Are 1031 exchanges at risk if Congress closes the tax loophole?

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 – all while the government responds 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 Assembly Bill 1253 aimed at those who earn more than $5 million 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. 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 rises 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 eliminating this “loophole” and generate billions in tax revenue. It currently works like this: If you sell a piece of income property, you are allowed to defer your long-term capital gains taxes. Simply, the seller enters a contract, creates a qualified intermediary before closing, closes, net sale proceeds go into an accommodator account, the seller identifies an upleg purchase within 45 days from close, and buys the upleg 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 hains 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.

Commercial property owners often ask me this question when I visit: 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 that 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. 

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Why business transitions are soaring: Sales, exits and shutdowns

Family-owned and operated businesses are the lifeblood of our California economy. I am passionate about helping them create legacy wealth through commercial real estate ownership.

One of the coolest things I observe during my daily grind is the many ways Californians make a living. The entrepreneurial spirit is amazing. However, many of our family-owned and operated manufacturing and logistics clients are facing a transition in their business which leads to a commercial real estate decision.

These transitions include:

Reorganization from COVID-19 upheaval.

Sadly, the pandemic has brutally thinned some industries. Others have crushed it. I walked the bulging warehouse with a chief operating officer of a family-owned and operated business last week. They supply fabric to the likes of Walmart, Joanne’s and Target. With stay-at-home orders, more folks are sewing and their sales have exploded.

Forward-looking, their facilities will not handle the uptick in orders. We are exploring ways to minimize their short-term pain, finding them more space, for now, vs. a longer-term solution.

On the flip side, a client who once supplied lights, video screens and temporary power to concerts, festivals and sporting events has no more business. Gone! Just like that. A thriving enterprise evaporated. Our task is more somber as we work through an excess of space, relieving this company of its lease obligations.

A sale of their operating company or acquiring a competitor.

Never since the halcyon days of Gordon Gecko have we seen a spate of mergers and acquisitions like now. Private equity capital – seeking favorable returns – has poured into traditional manufacturing. Plastic injection molding, aerospace tooling and packaging have found renewed interest from these groups. Common is a “roll-up” of these separate operations into a larger entity.

Generally, the play is to manage the companies for a few months or years, continue to acquire additional units, shed the unprofitable pieces and then resell the consolidation.

What is created is a duplication of facilities — akin to a “yours, mine, and ours” that occurs when a family is blended. Cultures must be morphed, excess real estate shed and a balance struck.

Relocation out-of-state.

California has made life quite difficult for anyone starting or managing a business. A noose of strangling regulation – licensing, enviro compliance, conditional use permitting, zoning – hangs over new and existing companies.

Layer in a few wacky – sorry – new laws such as Assembly Bill 5 (which unravels the way in which independent contractors are classified), the pending Proposition 15 (if passed, would tax commercial real estate differently than houses), and the new marginal tax rate – highest in the country – and you too might consider a moving van to tax- and regulation-friendly states such as Texas, Nevada and Arizona.

The outmigration is startling yet understandable. Left behind are industrial buildings that must be leased or sold.

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.

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What can loss teach us about commercial real estate?

Loss — “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 canceled – all losses – in some cases forever. We are required 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. Thought suffering from a terrible bout with cancer, Dad’s final days were peaceful.

He left a legacy of five children, 10 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, you might be wondering, what does loss have to do with commercial real estate? Only this. From loss comes gain. Here are a few examples.

Let’s go back to the Great Recession. In 2008, the year 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, you read that right. 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. It offers online content for owners and occupants of industrial buildings in Southern California.

My 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 2010s 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 or phones instead of visiting a brick and mortar store. Logistics companies that feed the supply chain are hustling to fulfill demand.

Material handling outfits such as 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 so, you ask? Brookfield Properties made an enormous bet on mall ownership in 2018. Now 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 for 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 — a commercial real estate brokerage. What I viewed as a 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.

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Avoid a re-trade by getting ahead of buyer requests

Last 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 whether or not to proceed to close.

As you recall, the four outcomes are move forward, cancel, seek additional contingency time or ask for a price reduction — also known as a 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 process. 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 be prepared. 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.

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6 elements of a best and final offer during a pandemic

Our economic engine in Southern California is starting to rev in anticipation of another race. Recently we’ve seen renewed activity by occupants seeking locations and investors with dry powder to deploy.

There is rumor of distress in some commercial real estate sectors — especially retail and office space. In my world of industrial buildings, not a lot has changed.

Certainly, buyers are proceeding cautiously, lenders are squirrelly and sellers wonder what the post-virus values will be. Until recently, no one really knew what impact an 11-week business shutdown would impose.

I’m pleased to say – at least with my narrow perspective – we’ve not experienced a dramatic tumble of prices. Quite the contrary. On one offering in particular, we had a bidding war!

So, if asked to dress in your Sunday best, here are the six points to consider.

Price

Maybe your initial offer was your best. Or maybe you’ve got a little gas left in your tank. Most sellers these days are focused upon the certainty of close. They may be on the heels of a deal cancellation – their buyer didn’t perform – and now they are back on the market. Or they’ve been available for some weeks and have recently reduced their asking price.

Regardless, give great thought to the highest you can pay – and close!

Terms

Generally, commercial real estate transactions include a period of time to study the property, accomplish inspections, confirm zoning and use, and potentially secure financing – all as contingencies to moving forward.

Unlike residential purchases that carry pre-set time frames, our number of days can vary. Post-COVID timeframes to engage consultants and conduct property tours have stretched. Before you commit, talk to your vendors and get an understanding of how quickly they can react.

Deposit structure is big. Offer the greatest initial and post contingency amounts you can muster. This will give sellers confidence in your ability.

Source of funds

We saw several deals – that had loan approval pre-virus – sputter at the finish line. In some cases, the culprit was the drain on cash flow caused by Payroll Protection Plan loans.

Touted as forgivable – but with a catch – lenders approving building loans must take into account the worst case – that the amounts must be serviced.

Buyers relying upon capital partners also received a shock when institutional sources of funding hit the pause button in late March. Anticipate a seller’s concern and confidently “show him the money”!

Qualifications

You want to demonstrate this is not your first rodeo! If you’re an investor, how many other deals have you bought? How familiar are you with the market – therefore rents and selling prices? How competent is your organization? Do you have property management or will you rely upon a third party?

Generally, a buyer that has a need for his operation will nudge out an investor who must rely upon the income.

Challenges foreseen

Will your use be approved by zoning rights or will a lengthy dance ensue? This is the moment to be quite transparent with your seller. Are you concerned the roof may leak? Wondering about access and therefore an easement? What else will preclude you from closing? Is your funding committed?

A surprise at the end

We recently conducted a “best and final” process for a seller who got seven offers!

We asked for their best shot. Three upped their numbers and one dropped out of the running. Six remained.

Akin to an episode of “Survivor” and based on certainty, net proceeds and qualifications, we narrowed the field to three and conducted buyer interviews. (ZOOM is good for that.)

What surprised us was the final kick for one of the buyers. They offered a portion of their deposit to be non-refundable day one! Talk about confidence. But it was a bit too late and the seller opted for another buyer.

Frankly, the decision was made on an intangible – the gut feel of the seller. I certainly hope they chose wisely!

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 714.564.710.

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How will COVID-19 affect commercial real estate values?

As California’s stay-at-home order is slowly lifted, our economic activity – placed into a self-induced coma – is also emerging from the ether. The most common question we hear these days is “what is my building worth?”

As recently mentioned in this space, no one really knows. For an investor value depends on the capitalized net income of rents. An occupant? The price of utility with which an occupant’s operation relies.

In the former, how will rents be impacted and at what return percentage will the market place settle? Pre-COVID found yield requirements in the 4.5-5% range. Now it’s anybody’s guess. In the latter? Will business failures cause a greater supply of functional locations from which to transact?

Today, I will take a deeper dive – anecdotally – into where commercial real estate values may be headed. Spoiler alert. In this columnist’s opinion, don’t look up.

Investors – capitalized net income: Those who rely on rents generated from commercial real estate approach value differently than residents of their business locations.

Let’s use this simple example. If annual net rents are $12 and the market return for this income is 5% – the resulting price per square foot is $240 – $12 divided by .05. As you can gather, a change in rents can skew the net income.

If returns are no longer 5% but hop to 6.5%, there’s a decline in the results. Again, annual net rents dropping to $10 with a 6.5% return yields a capitalized value of $153 per square foot. Wow! That is a precipitous fall.

In reality, the analysis is a bit more complex as things such as length of the lease, credit of the tenant and sustainability of the income are considered.

But simply a decline in rent or an increase in the market return spells doom for the worth of commercial real estate.

A couple of weeks ago, an investor friend of mine shared with me a conversation he had with a tenant. Approaching a lease renewal pre-virus he and his occupant were discussing a rate of $1.10 per square foot or $13.20 per year. Unable to reach agreement, they hit pause as the virus overtook our society. Eventually, they settled at 90 cents per square foot.

Simply waiting 45 days saved the tenant 20 cents per square foot. As the investor will not be selling – thus the decline in value will not be realized – he will nonetheless receive significantly less income. This illustrates how rents may adjust in the weeks ahead.

Additionally, if a vacancy is marketed and takers are few. an owner might sharpen his pencil to lease the space. Yep! Another data point for rent reduction. As these new comps filter through our industry, rates will reset.

Owner-occupants – utility: Most who own and occupy commercial real estate with their business don’t speak the foreign language of capitalized net income.

You see, the value they place on commercial real estate relies more on their use of the location and the corresponding payment for that utility. Consequently, if a cheap building has crappy loading, insufficient power or is miles from the freeway very few suitors will surface making it worthless to most occupants.

Making, shipping or servicing goods carries a profit structure independent of the buildin’gs worth. Sure, real estate has its place in the cost structure of said products, but ultimately whether that expense is a rent check to a landlord or debt service to a lender is immaterial. The ordinary business expense is the same.

I know, I know. There are infinite tax benefits to paying yourself rent vs. a landlord but that’s a conversation for another column.

Typically, if space is needed, the local inventory of available buildings will be scanned, toured and analyzed. Culled will be those not fitting the amenity requirements.

Considered? What rent will be paid if leased vs. what will a mortgage payment harbor. Simply, value for an occupant is largely determined by the number of avails that correspond with the needs.

Corresponding interest rates from which a location may be financed? Sure! Low rates can bridge the divide between the price to rent vs own. But, ultimately the location MUST have the goodies.

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.

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5 weeks down: What I’ve learned from stay-at-home mandate

Commercial real estate is a contact sport requiring face-to-face, arm-in-arm, hand-to-hand interaction.

Or does it?

On March 16th, we made the decision to allow one of our employees to telecommute. She was in the high-risk category for a COVID-19 infection. The next day we sent our staff of five to work remotely. All agents were encouraged to engage off-site as well.

This was three days before our governor’s executive shelter-in-place order took effect March 20.

Full disclosure: I prefer to toll my craft while mobile and have worked since 2014 to replace any legacy desktop program in favor of those I can access from anywhere — the driver’s seat of my car, a coffee shop, the front porch of my house or a client’s lobby.

Those mobile platforms include CoStar Go, Reonomy, ClientLook, Dropbox, Zoom, and Mailchimp.

However, woven into the fabric of my vocation is a steady stream of client meetings, prospect discovery discussions, building tours, group conferences, networking events, lunches, coffees and the like. With a full stop on any physical contact, lest we endanger the weaker among us, what follows is what I’ve learned from sheltering in place.

Meetings can still occur

How many people just four short weeks ago had never heard of Zoom let alone used it. I’ve been a Zoom user for several years, but I’ve become quite proficient in requesting, scheduling, hosting, and recording individual and group meetings. Maybe not quite as effective as in-person but very close.

Building tours are challenging

Probably the biggest obstacle to the stay-at-home order has been touring available properties. A combination of FaceTime, virtual tours, and yes, Zoom, are the workarounds.

Working remotely is more efficient. Roll out and get to work — simple! No driving allowance or delays. Just pure work time.

Less on dry cleaning

Who cares if you wear the same shirt twice or more? No starch, please. I’ve not shimmied into a suit in weeks. I’m a bit nervous about the COVID-19 – not the virus but the 19 pounds!

No traffic: I’ve not sat in traffic for weeks. Brilliant! Plus, I’ve not been late. In the absence of driving to appointments every day, I’ve found two or three hours not claimed before.

Deals are happening: Especially essential ones – tax deferred exchanges, lease renewals, and marketing vacancies.

Folks are talking about “what’s next.” What’s next will be the subject of next week’s column.

Stay well, dear readers. That light you see is, in fact, the end of a tunnel not an oncoming train.

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.

 

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Bright spots in a dark coronavirus-affected commercial real estate world

Those of you who know me realize I’m a “half-full” guy, an optimist. After all, commercial real estate brokerage requires us to be upbeat.

Transactions can be clipping along nicely when something unforeseen derails them. To keep deals on track, you need to believe things will work out for the best using solid resolve and having a problem-solving attitude.

Frankly, I was a bit down last month when our world morphed into the reality of COVID-19 quarantines, a precipitous drop in business, working remotely and staff furloughs.

We were bombarded every day with a torrent of terrible tales, increased body counts and venue closures. I had to turn off the news, pull myself up and return to my daily routine of advising commercial real estate owners and occupants. By what should I say to them amid the uncertainty?

Well, as thin as these words appear, we are all in this together. No one’s to blame. In order to survive, we must cooperate. Communication is key. Our clients want solutions.

So, I pivoted into a resource and developed talking points for rent forgiveness and how to request mortgage relief. Numerous webinars educated me on the CARES Act. I attended ZOOM calls with strategic partners such as wealth managers, bankers, commercial insurance brokers, mergers and acquisitions, accounting, human resources and legal professionals.

What developed was a nice list of the assistance I could provide. So, I started dialing the phone.

As the phone calls added up, what I didn’t anticipate were the bright spots in an otherwise dark world. Indulge me while I share a few.

One of my clients applies adhesives to rolls of tape. His business is booming! Why? Admittance wrist bands to hospitals are supplied by his main customer.

Aerospace tooling operations are bustling. Military airplanes are still flying. Parts are replaced. Plus, many make ventilator components.

I got a request recently from one of my colleagues. A company has countless drums of hand sanitizer scattered across the nation. What they needed was a plastic bottle manufacturer who could blow mold the bottles and fill them — immediately.

Speaking of sanitizer. How about my client who builds the metal bases on which the sanitizing stations rest. Yep. Crushing it!

You’d believe pool chemicals might be a bit of a luxury. Not so! Pools must be kept clean and germ-free lest the bad virus starts to grow. My supplier of pool chemicals has benefited from a pop in sales.

Construction crosses many subsets of industrial occupants. All are essential to keep the infrastructure humming – heating, cooling, electricity, roofs and the like.

As our society adjusts to online ordering and home delivery operations such as e-commerce, transportation and maintenance of vehicles are slammed.

Empty store shelves require replenishment. Anyone along the supply chain – makers of toilet paper, warehousers, truckers, and grocery store personnel — are working non-stop.

Akin to the aftermath of those devastating brush fires which blacken the landscape – green shoots of do appear.

Stay well, dear readers! This too shall pass and we will be stronger and better as a result.

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.

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What does coronavirus mean to commercial real estate?

“Coronaviruses are a group of viruses that cause diseases in mammals and birds,” says Wikipedia. “In humans, coronaviruses cause respiratory tract infections that are typically mild, such as the common cold, though rarer forms such as SARS, MERS and COVID-19 can be lethal. Symptoms vary in other species: in chickens, they cause an upper respiratory tract disease, while in cows and pigs they cause diarrhea. There are no vaccines or antiviral drugs to prevent or treat human coronavirus infections.”

OK, “so what?” you might ask. How will the potential coronavirus pandemic affect commercial real estate? Indulge me while I review a few ways.

Uncertainty

When the stock market gyrates wildly, as it did to close out February, some people get nervous. After all, trillions of dollars in paper wealth evaporate. As folks glance at their diminishing 401(k) balances, an air of uncertainty balloons. If resulting angst causes consumers to hit the pause button on spending, a ripple forms in the ocean of economic activity.

When attendees avoid concerts, sporting events, movies or their favorite restaurants, businesses suffer a decline in sales. Operations that supply these enterprises — trucking, food, linens, security, novelties — then feel the pinch as the ripples become waves of lost opportunity. All of these institutions rent or own commercial real estate. You get the idea.

Supply chain disruption

As mentioned last week, steel production is down 90% in China. Auto sales in Asia? Off a whopping 95%! One of the Port of LA’s largest exports is auto parts. Couple these factors with the typical container cancellations during the Chinese New Year and you create a lag in product delivery.

Travel

Hotels, airlines, rental cars, tickets to Disneyland, Knott’s or Universal – yep! Much of Orange county’s economic vitality relies on tourism. Postponing travel equates to lost revenue for all who depend on customers to serve.

Interest rates

If there is a bright side, it may be favorable interest rates which, in turn, make commercial real estate financing more affordable. Mass stock market sell-offs generate a load of proceeds that must be invested.

Typically a safe harbor for this wad of cash is short-term instruments such as U.S. Treasuries. As the demand for T-bills increases, so does the price. Price increases cause returns to react inversely. “The 10-year U.S. Treasury yield plunged to a fresh record low on Friday, Feb. 28 as investors dumped riskier assets and searched for safer options amid the coronavirus outbreak,” according to CNBC. “The benchmark rate traded around 1.16%, marking the first time ever it traded below 1.2%. The 2-year rate slid to 0.95%, its lowest level since Nov. 2016. Yields move inversely to bond prices, which are rising as purchases surge. The 10-year yield has tumbled 25 basis points this week alone as the massive sell-off in stocks intensified.”

Well, at least surgical mask sales are on the rise.

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.

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Why most commercial tenants must sign a personal guaranty

In my 35 years of experience as a business owner and lease negotiator for corporate America and small business owners, the most common element for most small business owners when signing a lease is the personal guaranty vs. a corporate guaranty for large corporations.

I’m frequently asked by business owners if the personal guaranty can be omitted when signing a lease. Unfortunately, it is a requirement in all leasing transactions with small businesses.

There are a few exceptions when a commercial landlord will accept a letter of credit or other substantial collateral in lieu of the guaranty, but 99% of the time, a personal guaranty cannot be avoided.

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There are many reasons for this requirement. First, the landlord wants assurances the lease obligations will be met by the business owner, and as an incentive, they want the lease backed by the personal guaranty, therefore, making it more difficult for the business owner to simply walk away from the lease if the business is not doing well or as well as expected.  The most common type of leases containing personal guarantees is a retail and professional service business such as medical/dental leases.

There are, however, some methods to negotiate these personal guarantees that can be employed in leasing transactions. The most recommended method is to use a limited or rolling guaranty. These methods are sometimes acceptable to landlords, depending on the business owners’ credit, financial picture and business experience.

The stronger the qualifications, the better odds of being able to negotiate. Keep in mind, especially when the landlord is spending substantial money on tenant improvements or providing a substantial tenant improvement allowance, which is in the tens of thousands or hundreds of thousands of dollars, they want protection for their investment when leasing their buildings or shopping centers to hedge their risk.

One of the more effective negotiating models is to ask that a rolling guaranty be effective after a negotiated amount of time has passed during the initial term of a lease, and provided the business owner has not defaulted and paid their rent timely.

The most common type of limited guaranty is the 12-month rolling guaranty. This means, after a certain amount of time has passed during the lease term, the business owners’ liability is limited to 12-months of rent payments vs. the entire amount of the lease obligation.

Depending on how long the lease terms are, I typically see 12-36 months after a lease term passes that a full lease liability can convert to the rolling guaranty. In other rare instances, the lease guaranty can burn off entirely without any continuing liability such as the rolling guaranty after a certain amount of time on a lease has passed.

The most important items to the landlord when leasing commercial space to a business owner are: credit, net worth, liquid assets and related business experience. The stronger these items are, the better your odds of negotiating the guaranty.

In some instances, the landlord will require 2-3 months security deposit if these important items are not strong enough to provide the landlord a comfort level when leasing the space. The increased security deposit is in addition to the personal guaranty.

It’s important for all small business owners to know that if they ever sell their business, their personal guaranty can continue in perpetuity unless negotiated at the time of sale. This basically means if the buyer of their business defaults on the lease, the landlord can come after you.

It’s also very important that a prospective buyer is well qualified, not only because the landlord has the right to approve the buyer known as a lease assignee, but also for the benefit of the seller of the business to ensure a lower likelihood of default and being obligated for the unpaid lease obligation if the buyer becomes insolvent.

In other words, the seller of a business has to think like a landlord in these cases.

Todd Dorn is president of The Lease Doctor and Dorn and company-commercial lease advisers. Reach Dorn at 888-413-7699 / 951-659-3163 or at tdorn@theleasedoctor.com.

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