How do horses for courses work in real estate?

In my formative years in Texarkana, Arkansas, I played a fair amount of golf. You see, I was too slow and skinny to play football and found it difficult to create space under my sneakers – making basketball a non-starter, too.

We didn’t have the cool school sports of today such as lacrosse, swimming and volleyball. Who knows? I might have sucked at those as well.

Relegated to the golf course were my extracurricular sporting efforts. A saying during that time, “horses for courses,” became a part of my lexicon. It describes how certain golfers do well on specific golf courses while others languish. Jack Nicklaus won six Masters green jackets on one course while Lee Trevino never won at Augusta National. Weird.

You might be wondering, what the heck does any of this have to do with commercial real estate? Please indulge me as we play a round, figuratively speaking.

As described many times in this space, industrial occupants are either manufacturers, warehouse logistics providers or some combination. Think plastic injection molding, aerospace tooling and Ramen noodle producers. They all make a product.

Raw materials are received, a process is completed, the finished goods are temporarily stored, and out the door they go. Simple.

You may be thinking. Hmm, are the types of companies above manufacturers or warehouse logistics operations? After all, some things such as raw materials and finished items are stored and shipped. They are by definition manufacturers because something that enters – flour, oil, and water – exits differently, say, like Ramen noodles.

So with that context, what kind of “course” does this “horse” need in order to succeed?

Certainly, a building zoned for manufacturing, which is generally classified as M-1, M-2, light or heavy manufacturing or business park. Next, given the specific process undertaken such as the case of our Ramen guy, where and how (truck or rail) will things such as flour, oil, and water enter the plant?

Once in, will they be stored or thrust immediately into machinery? How will the enterprise deal with its layout? We’re making food. Can a dirty warehouse suffice or will we require a more sterile area?

Those large mixers, boilers, and cutters will require many amps of electricity.

Finally, will the finished food be temporarily warehoused or packed onto idling trucks? As you can appreciate, not every “course” will be suitable. So, critical things include power, appropriate zoning, layout conducive to food production, and adequate ways to get in and out. Less important are amenities such as the height of warehouse ceilings, fire protection for the high-piled commodities and massive truck courts.

Let’s now shift to our warehouse logistics operators. The easiest of the bunch to describe is Amazon, the Masters (sorry!) of supply chain distribution. Simply, all of the items you source, click and purchase from your device follow a similar path.

Someone – not Amazon – but like the manufacturers described above, makes something. In the case of a Kohler faucet, look to Wisconsin. A Kraus sink? China. A head of lettuce? The San Joaquin Valley. Then the gargantuan Amazon distribution center gets it, by ocean container or rail to truck, refrigerated or not, to its warehouse. Your online order is received, picked, packaged, boxed, labeled and shipped to your door. Boom.

I’ve over-simplified the entire supply chain, but you get the idea.

In order to efficiently house an Amazon warehouse, certain features are mandatory. Clearly zoning. Some cities limit truck traffic. Ooops. Can’t go there! Because of the volume of goods at intake, logistics types need a significant number of doors that can unload trucks. Now what?

Well, pile it up as high as possible inside. You’ll need to think about the stacking height and whether the stuff will burn. For example, our Kohler sink will not burn but our plastic bottles of shampoo will. Therefore, the fire department will have a say on the fire suppression used.

Even with all the prevention in place, an Amazon warehouse burned to the ground last year in Redlands.

Finally – and in an ideal setup – different doors capable of loading the orders onto departing trucks or vans. Less important? Power. Because production machines aren’t employed.

As if the amount of available inventory was not acutely lacking, now we understand why not every “course” fits the “horse.” This only limits supply further.

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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Love language in real estate: Why people and their skills matter

If ever you doubt the power of digital reach, please consider this brief recap.

Flashback 11 years. My bride of 31 years at that time suggested I “work out loud” while transacting commercial real estate. What the heck does that mean? Simply, put in digital form, those tasks you accomplish daily could help someone searching for “how to.” Boom. Brilliant.

So, I started my Location Advice blog, which provides the columns you read here. Here’s where the reach comes in. Hiding in my inbox last week was a note from Chad Massaker, a commercial real estate strategist with The Pisaneschi Group at Compass Commercial — in Palm Beach, Florida. Wow!

You see, Chad read a column online from two years ago on the Love Languages of Commercial Real Estate. If you missed it, you can quickly catch up at bit.ly/3Grxdh6

I found Chad’s comments column-worthy. So from my new digital connection in Florida, here it goes.

I feel that there is a little bit of each type in each agent, but I am only two years in as a CRE agent. Here’s what do I know:

— I’ve traditionally been the relationships and network archetype all of my life in business. I’m not sure how the relationship part plays out once I sell a building to an owner-operator, and then they have no need for me for years, if ever again. It’s not like my IT company in Atlanta, where conversations were ongoing.

— Definitely hate the legalities and drama archetypes. Talk about people who can’t get out of their own way. Probably the arch-villains.

Here are a few more I would add to your list:

— Good enoughs: Incredibly lazy agents who post only the bare minimum information on a listing, making you call them for the info, which half the time they don’t have. “What do you mean you don’t know the clear height of the warehouse you have listed?” They also take advantage of the owner’s ignorance of how real estate is marketed – not just listed.

–Ignorers: Agents, who with a high degree of certainty, never answer their phones and only rarely (if ever) answer their texts or emails. These also tend to be the same people that leave For Lease signs up on their building and listings live on CoStar despite being at 100% capacity. I love these types. They give us a lot of business.

— Lifetime Realtors: Instantly recognizable when speaking with entrepreneurs, owner-operators, etc., on the buyer/tenant side because they have never run a business before. Their knowledge drops off a cliff outside of real estate. Real estate was probably their first career and it is all they’ve known. Also, these people tend to be relationship and network types in my experience.

Well done, Chad! I’d say there’s a news organization in South Florida that would publish your writing.

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’s the real cost of a real estate downpayment?

As you’ve read here a number of times, buying commercial real estate is a great way to build generational wealth. It’s like a jelly of the month club. By that, I mean the gift that keeps on giving!

Many who read this column have founded an enterprise housed in a parcel of commercial real estate which they also own. So, the occupying company earns income through its business operation and pays rent for use of the building. Company value increases over time and the address appreciates. A double whammy!

Southern California has countless entrepreneurial stories whereby a generation took a risk, formed a company, bought a location and succeeding family members benefited. I have the privilege of counseling these family-owned and operated manufacturing and logistics businesses.

Recently, a conversation struck me as particularly column-worthy. Specifically, how much should be allocated for a down payment when considering a buy? The easy answer is 10% of the purchase price if leveraged through the Small Business Administration and 20-30% when financed conventionally. Boom. Done. See y’all next week.

But, wait, there’s more … substantially more to the story of originating a loan. So, please stay tuned for a minute more.

In addition to the 10-30%, suggested would be to budget for the following:

Appraisal: Regardless of your lender choice – SBA, bank, insurance company, or hard money – an appraisal will be completed. Contained within the bank’s underwriting is a confirmation the price paid is in line with the market. Plan on $2,500-$5,000 for this review.

Environmental: Lurking beneath the surface of your purchase could be a problem. These unseen issues are caused by something toxic deposited in the soil. A review of the previous occupants in the building, messy neighbors, and the smokestack down the street combined with a look at old aerial photos – forms what is known as a phase I environmental report.

Generally, this does the trick and provides a clean bill of health. If environmental concerns rise – such as stained concrete or containers of waste – a phase two will be employed. Soil borings are sampled and tested. Recommendations range from no further action to remediation.

Have you ever seen a pile of dirt inside yellow tape next to a gas pump at your local station? No. It’s not an episode of CSI. Aeration is one way to get the bad stuff out of the soil. Plan on $2,500 for subsequent phases if remediation is required.

Legal: You’re going to want an attorney to review the purchase agreement, title commitment, and draw your LLC formation documents. Budget around $10,000.

Escrow and title: Sure, the seller pays for a standard policy but any lender policies or extended coverage are yours to bear. Plus, you’ll pay half of the escrow fees. Another $10,000, but that’s dependent upon deal size.

Survey: This is not always necessary unless you’re after an extended policy of title insurance. Unrecorded easements, abandoned driveways, and recorded leases are typically not covered with a standard policy. Utility locations, property lines, and underground pipes are clearly mapped as well. $5000 is reasonable.

Loan points: In addition to the interest payments due over the term of your debt, you’ll pay a percentage of your loan amount to the bank. 1-2% is pretty typical.

Cost segregation: One of the really cool things about owning commercial real estate is the depreciation that lowers your income tax burden. The improved portion of your parcel – the buildings – can be depreciated over 39 years on a straight line — 1/39th each year. But other components of the improvements such as walls, doors, glass and air conditioning have a shorter useful life, and if properly segregated, can be written off sooner. Usually, your CPA can help with this. She’ll want to be paid, though. $15,000 seems fair.

Once you become the owner, gather and total your receipts. Add all you spent to the 10-30% down payment. What results is the “true” investment into your buy.

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 will come of commercial real estate tax breaks?

As one Register columnist once wrote, “they’re only opinions, but they’re all mine!” Today, I purge my inbox for another edition of a random commercial real estate thoughts. I find the occasional purge cathartic. So here it goes.

Gender reveal. Some of you may have noticed my more frequent use of “she” when describing the gender of property owners or tenants. Yes, one of my readers scolded me. I realized I had erred and thus the morph. So, sorry if I offended.

Insomnia. My recent column on the number one problem I hear voiced by business owners – a lack of skilled workers – met with some commentary. Specifically, my reference to our “subsidy” for those without work. The fact remains: Unemployment is rampant and we’ve done a poor job training our youth in the jobs that exist, specifically the trades.

Electricians, carpenters, structural steel erectors, concrete finishers, roofers all crowd any construction site. These craftsmen create the concrete caissons commercial real estate agents are tasked to fill. Unfortunately, there’s a huge yawn with those trained in more white-collar arenas, especially over a certain age. However, I don’t see these capable grey hairs as candidates to build structures.

Frothy or calm. Folks ask “how’s the market?” I respond with “it depends.”

If your specialty is industrial – manufacturing and logistics properties and you represent owners – you are an order taker. You simply manage the flood of activity surrounding your offering and choose from a number of takers.

Conversely, counseling tenants or buyers often fills the day filled with endless searches to locate an availability and setting expectations when one is uncovered. The rules pursuing an off-market offering change. Owner motivation is not as keen. Brokers who market suites of offices must deal with systemic uncertainty. Questions such as – “how much space do we actually need and when” are board room topics.

Coming downturn. “When will the music stop” columns always garner some interest. Inflation is rampant, supply chains disrupted, shortages of everything occurring, and national debt levels are rising yet we continue to torpedo previously high sale and lease comps. These days we are forced to price offerings as TBD – a hedge against leaving dollars on the dais.

Finally, what will the balance of 2021 bring? Many say it will be more of the same. Some are wary and see the amount of government spending massing on the horizon and are preparing for a trove of tax law changes.

After all, we must repay the debt somehow, right? Are the tax strategies such as carried interest, tax-deferred exchanges, and long-term capital gains – which play into commercial real estate activity – in jeopardy? Many believe so. Others realize the massive lobby the real estate business leverages and are secure. Hopefully, any change will not be retroactive.

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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When a real estate deal stumbles, what fixes can be made?

Last week I reviewed the steps in buying commercial real estate. Whether you’re buying to house your company’s operation or simply to enjoy the rent a parcel produces, the steps are essentially the same.

The possible exception could be the financing portion, which some investors abandon in favor of deploying large sums of cash into the buy.

Today, I will complete the orbit and describe some deal challenges that can occur and some suggestions on how to overcome them.

From last week:

Due diligence, also referred to as a contingency period, ranges from as few as 15 days to as long as 90, and a ton of work must occur during this time frame. Financing must be secured, title exceptions approved, inspection of the building – roof, electrical, HVAC, etc. accomplished, vesting documents drawn, financial aspects of the tenancy – if any – analyzed, and environmental health diagnosed.

Whew! Within each of the main categories of approval, there are checkpoints which guide toward the end. Financing, for example, involves credit of the buyer, the tenant, an appraisal, an enviro report and lender concurrence. There’s a lot to be done in a short time. What if something isn’t approved?

That, dear readers, is a subject for today’s column.

So, here it goes.

Generally, purchase and sale agreements include a mechanism for solving issues that arise in a deal.

The most widely used contract is published by the Association of Commercial Real Estate, or AIR. Clearly defined within paragraph nine are the various categories of approval items — inspection, title, tenancy, other agreements, environmental, material change, governmental approvals and financing. Within the boiler plate language are roadmaps for resolution.

If your contract is not the standard AIR form, results may differ. As always, it’s wise to seek legal counsel before engaging. But within the document, typically there are three choices – cancel, accept or fix. A fourth can creep in, which is a buyer-seller compromise.

Indulge me as we walk through some quick examples.

Let’s say a building inspector discovers the HVAC units are past their useful life. From experience, I can say this scenario is quite common. So, here’s what happens.

The buyer objects to the condition of the cooling systems by disapproving a portion of the physical inspection contingency. You may be wondering, wait, I thought the buyer was buying the building “as-is, where-is, with no seller warranties.” She is, but she’s also relying on her inspection to alert her to any fixes necessary. Confusing? Yes, it is.

Sure, a seller may simply refuse to repair or replace the units and cancel the escrow, but they cannot do so immediately. You see, here’s where the “mechanism” takes place. The buyer objects; the seller has 10 days to respond — yes, no or maybe. A no vote on the recall – ooops, sorry. Wrong issue. If the seller refuses, the buyer can cancel the deal within another 10 days, opt to continue and buy with the faulty units, or accept a compromise — the “maybe” offered by the seller.

Financing is trickier.

You see, if the buyer is unsuccessful in their pursuit of a loan by the date specified, generally, the seller can walk away. Therefore, it’s imperative to be quite transparent with the seller during the loan approval process. Because prior to the financing condition date, there may be some leverage.

If an appraisal comes back less than the contract price – which causes a lender to renege on the amount – it’s recommended to level with the seller.

Yes, you or the seller can cancel, additional dollars can be added to adjust for the delta – accept, an appeal can be made to the lender – buyer fix, purchase price can be reduced – seller fix, or a compromise between buyer and seller can be struck whereby buyer adds some dough, seller reduces the price – and voila!

I’ve witnessed these go every way you can imagine over my decades in the business. One certainty – there will always be issues. It’s a thing.

The next deal I close without one will be the first. But, fair warning. In today’s overheated industrial market, I’d not plan on a seller being terribly receptive to what’s referred to as a “re-trade.” Chances are there is a line of suitors waiting for the chosen buyer to blink.

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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Things to consider when buying a building

Commercial real estate ownership – especially when it houses a business operation in which you have a stake – stabilizes your costs, provides some tax breaks and appreciates over time. The trifecta!

Here’s a breakdown of things to consider …

Cost stabilization. If you rely upon a series of 3- to 5-year leases as a location strategy, over time the rental rates will increase based on the change in the consumer price index or by a fixed annual amount. Sure, you might time a dip in the market with an expiration, but don’t count on these ends meeting very often. So, using fixed-rate debt over a 20 to 25 year amortization period can provide a level amount.

Tax breaks. Infinite are the incentives Uncle Sam provides for those who own income property. Mortgage interest, operating expenses and depreciation can all be deducted. In some cases, capital outlays, such as a new roof or parking lot, can be expensed.

Appreciation. Depreciating an appreciating asset is one of the marvels of commercial real estate investment. As an example: Say you buy a structure for $5 million. The improved portion (not the land) can be depreciated over 39 years. But at the same time, over a 10-year span, your $5 million asset could be worth double!

With these benefits, you may be wondering. Why don’t all companies own their buildings? Why would anyone lease? And what should be considered before buying?

Fluctuating space needs. Many fast-growing operations opt to lease vs. own. You see, the amount of square footage required can vary. If you own and outgrow the footprint, money is tied up in a facility that is obsolete. Conversely, a series of short-term leases and options to extend can handle the fluctuations without consuming precious capital.

Use of the down payment. Most investors finance an owner-occupied commercial real estate purchase through the Small Business Administration. Originated is a loan for 90% of the buy with the balance coming from the borrower. But 10% of a $5 million deal is still $500,000. In some instances, this capital can be better deployed in new employees, machinery or equipment.

Financeability. A lender considering making a loan will look at the creditworthiness of the borrower as well as the occupying entity. Is the business cash flow – after all the expenses are paid – sufficient to service the debt?

Company structure. As mentioned above, depreciation – for those who can benefit – is awesome. Publicly traded companies frequently avoid ownership of their buildings so that depreciation doesn’t ding their earnings.

Age of the principals. Years are an important consideration as commercial real estate ownership is a long play. Meaning: If the principals are in their 80s, chances are great they won’t live to see the appreciation. Certainly, their heirs will thank them.

Exit strategy. Owning an operation should also be considered in light of your horizon for the enterprise. Simply, if you plan to dispose of the business within the next five years, what remains is the facility. I’ve witnessed this work quite well as the acquiring group needs a place to live and signs a lease. I’ve also watched the value of the operation be diminished because duplication of addresses can occur.

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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3 more ways you can avoid rent increases

If you read my column last week, you learned two key ways to avoid a rental rate increase — know your owner and understand the value of your tenancy.

If the bottom of your birdcage lands the Real Estate section before you read it, here’s a brief recap.

Industrial lease rates have increased a whopping 134% over the past 10 years. Recall, our market for manufacturing and logistics space was awakening from the ether of the 2008-2010 financial reset – err, meltdown and there were bargains galore. Now with the classic increase in demand from pandemic-fueled buying and a pinched supply of available buildings, rates have skyrocketed!

You may be fortunate to rent from an owner who appreciates your worth as a tenant and wants to avoid a costly vacancy if you bolt. If this is your situation and you’re approaching a renewal, count yourself among the lucky. Conversely, if maximizing the monthly income is your landlord’s objective, you could face an increase of double what you’re currently paying.

But, there is hope. Keep in mind these three strategies to stem a spike in monthly payments.

Buy a building

Historically, buying property has been costlier than renting on a pure monthly outlay basis.

Meaning, if we stack a mortgage, allotment for property taxes, insurance and upkeep together, the total will be higher than most leases. Plus, you must come up with a sum to bridge the gap between what a bank will loan and your purchase price, some 10%-25%.

However, this is many times shortsighted when looking at a projection over the life of a company’s occupancy. You see, lease rates escalate over time, generally fixed at 3%-3.5% annually. And, when a term expires, the landlord will bump the number even higher to compensate for the market variance.

Currently, we’re seeing a huge boost in rental rates which eclipses that 3%-3.5% annual escalator. Some find it better to own, finance the buy with fixed debt, thus stabilizing payments and enjoying appreciation and the tax benefits that accrue.

A word of caution. If you enter the buying fray, be prepared. Structure your A-game with proof of a down payment, lender pre-qualification letter, and a well-reasoned story of your desire to buy.

Move to cheaper geography

Once, the Inland parts of SoCal were cheaper, newer and alternatives were plentiful.

If you’re a logistics provider and you look East, this affordability gap is quickly narrowing. However, there are still “deals” to be found. Don’t forget areas just outside the state borders such as Arizona and Nevada. You might even find a business climate that welcomes enterprises with goodies such as tax breaks, employment incentives and fewer regulations.

Do more with less

We toured an operation recently. Occupied was a big chunk of a larger address. Since they leased the space five years ago, several distribution centers had been added to their supply chain, thus lessening their need for the square footage they leased locally.

By trimming their premises by 40% a great building popped up which fit their requirement. Another client of ours took advantage of the relative softness in the office space market and peeled away that portion of the company. Eliminating the people component from their warehouse created several new buildings to consider.

Don’t forget: Your additional capacity might be found if you look up and maximize your stacking. Frequently, a group will believe they are out of space because their floor is consumed. Ignored is the two or three feet in height not used. With the advances of material handling equipment – you can literally use every inch if you narrow your aisles and pile your product high.

More on these later.

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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Seen a dramatic rent increase? Here are ways to avoid them

Lease rates for industrial properties in Southern California continue to rise!

To place this in some context, if your direction as a business owner was to rent a location in 2011 and your operation consumed 100,000 square feet, you could expect to pay around $45,000 per month in rent.

Of course, charges for things like property taxes, insurance and maintenance would have been in addition to the $45K. Those additional charges would have added around $12,500 per month, bringing the total to $57,500 – or 57.5 cents per square foot.

Flash forward to our pandemic-fueled shortage of space these days and comparable buildings lease for $135,000 per month!

For those scoring at home, that’s a 134% increase in 10 years. Or, a 13.4% annual increase. Or as I like to call it, simply nuts!

Am I saying if you rented an address in 2011 and signed a 10-year lease – when your lease expires this year – you can expect your rent to more than double? Yes, You got it.

So, how are businesses able to afford such a whopping spike? Better still, are there strategies you can employ to stem the rent bumps? The answers are, I don’t know and yes. Indulge me as I outline a few ways to lessen the blows of gigantic rent inflation.

Know your owner

The gentleman to whom you send your rent each month falls into the category of investors. Your tenancy is singular or multiple. Unfortunately, if you’re one of many and his buildings are full, your leverage is limited.

You see, he may opt to push rents even if a move-out ensues. He’ll simply replace you. Conversely, if your rent is the biggest part of his retirement income, a bit more realism happens. If you relocate – and his music stops – so does his lifestyle. He’ll be more flexible with you to keep you in residence and avoid a costly vacancy.

Know your value

As a tenant, your worth is two-fold.

First, the capitalized income you pay each year determines the dollar amount of the investment. Simply, $100,000 in annual rent – at today’s cap rates of 4.75% suggests $2,105,263 ($100,000/4.75%) – if a sale or refinance was considered.

Why is this important? A bank would lend a percentage of this amount if your owner needed cash. Plus, the market would gladly pay him this figure if a decision was made to cash-in or redeploy the money into another income property.

Second, your tenancy is costly to replace. By this, I mean free rent, downtime, refurbishment, and professional fees are forked over to secure a paying customer.

So, let’s say the title holder of your location believes he can get $100,000 a year if you bolt. You currently pay him $80,000 annually. If he’s correct in his assumption, he can achieve approximately $538,406 if he finds a five-year tenant ($100,000 with a 3% annual rent escalator).

However, if he lays fallow for two months, incentivizes the new group with one month of free time, paints and carpets the offices, and pays a commercial real estate professional 6%, count on an up-front expenditure of $72,303 – ($16,666 for downtime, $8,333 in free rent, $15,000 for a fix-up, and $32,304 in fees).

If we subtract $72,303 from our expected new income stream of $538,406 our net take is $466,103 or $93,220 per year.

Say you’re willing to pay him $90,000. So, he could be slightly better off replacing you. But, if any of his assumptions are wrong – say, he sits four months vs. two, he is better off renewing you at $90,000 annually.

Presumably, you’ve paid on time, taken care of the premises and sent him a Christmas card. Those intangibles have credibility. He may have to chase the new guy to get his rent.

Know your alternatives. Don’t forget. You could buy a building, consider a cheaper area or opt for a shorter lease term.

More on these later.

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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With 2020’s crazy real estate year in mind, what does the rest of 2021 bring?

We now have eclipsed six months of 2021.

Costco already has Christmas decorations displayed alongside the red, white, and blue sheet cakes! But I digress.

Anyway, I thought it would be fun to review what this year has brought and what I see for the balance of 2021. It’s good to periodically clear my consciousness of clutter, so I appreciate your indulgence.

One year ago we got some great news on a deal we were transacting. The due diligence period ended, the buyer waived contingencies and we proceeded to close escrow on July 17, 2020. Boom! Why do I mention this? You see, this offering was originally launched in February 2020. Great timing, eh?

We quickly received an acceptable proposal and put the property under contract, just in time for the nation to hit the pause button. As you would expect, the deal blew up, we waited and re-launched the marketing in June 2020.

Our new chronology proved to be prescient as buying activity had returned with a vengeance. Candidly, the uptick in industrial demand has not stopped. If anything, it’s even more frothy than it was a year ago. But why? Manufacturing and logistics concerns were deemed essential. Replacement parts were needed for anything relating to home or auto.

And because people were stranded at home, they spent hours staring at their computer screens, ordering merchandise. All of these factors caused businesses – who make and ship things – to explode with commerce.

What is taking so long? I had a nice conversation yesterday with a moving and storage company with whom I network. He had just visited a tech company in the Inland Empire that is experiencing a transition. Apparently, a decision has been made to largely work remotely and therefore their former bristling bank of office suites will not be needed. They’ll attempt to find a surrogate to replace their tenancy. This is a classic example of the decisions that will be made by office occupants throughout the balance of 2021.

Now that we have a clearer path forward (until the next speed bump), folks are starting to return to the office — or not. We have a much better picture of exactly how much square footage operations require. But the market upheaval brought on by lockdowns has led to some uncertainty. Decision gridlock ensues. Long-term commitments – such as a multi-year lease renewal – are postponed.

Wayne Gretzky famously opined, “I skate to where the puck is will be, not where it has been.” It’s a popular quote because it vividly illustrates something that everyone wants to do, but may not understand how. You may be wondering what this has to with commercial real estate? Just this: Predicting where lease rates and sale prices will be in the upcoming months is next to impossible! Especially with inventory planned or under construction.

Admittedly, prices will be higher, but how much higher? That huge burden falls to commercial real estate practitioners who have to provide proper guidance to clients. After all, we don’t want to leave shekels on the sideboard. Vacancies are expensive, however.

So, if you press – which can cause a delayed occupancy – is the expense worth it? During this time I generally recommend pricing on a to-be-determined basis, which unfortunately is a bit of a cop-out. Occupants like to negotiate from an established ask vs. “you tell us what it’s worth” to you.

Let’s do this again next January – the predictions, not the pandemic – and see how accurate we were, shall we?

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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Sublease or buyout? Each scenario is messy for tenants

Situations change rapidly in California’s business climate. What happens when a business needs to pivot, quickly?

Recently, I wrote of the ways in which you can extract yourself or your company from a lease obligation.

As a quick recap: Leases are contracts that allow occupancy for a certain period of time (term) and for consideration (rent). As an inducement for your tenancy, an owner (landlord) may offer some goodies – free or abated rent, an allowance to fix up the place or the right to extend your lease or buy the premises (options). In return, you agree to pay on time, stay the full period of the lease and take care of the building. Easy, right? Not so fast.

Sometimes circumstances arise whereby the agreement must be tweaked. In the extreme, a dramatic decrease in revenue leads to bankruptcy. Conversely, an uptick in sales could cause the need for more space. If a competitor is acquired or if the operation is sold, another shift occurs. Now, you have redundancy — too many facilities serving the same purpose. What to do with your leases?

Remedies abound. You can sublease the building, buy out, allow the term to expire, reject the lease through bankruptcy or default. Clearly, the last two are not recommended as there are legal consequences, but they are a way clear.

Most opt for one or a combination of the first three, sublease, buyout or term out. But what are the differences and when should they be used? Please allow me to dive a bit deeper.

Sublease

Simply put, in a sublease you locate a surrogate — a group to replace you.

But, don’t forget, there may not be another “you” readily available. Did your operation lease the first building you toured? Probably not. You considered multiple locations until you found the perfect fit of lease rate, landlord motivation, amenities, concessions and term. Now, you are the landlord and must meet the nuances of tenants in the market. All, while having little flexibility.

Your goal is to get out with as little downtime and expense as possible. Remember, your rent and term are known. Where is that rate compared with comparable availabilities – above, below or right at market? If you’re below, count yourself fortunate! You’ve something to offer.

So, how do you deal with an enterprise seeking a three-year lease when you’ve committed to 10. Plus, you’ve consumed the inducements. By that, I mean your free rent burned off or the new carpet is old now. To compete, you may have to consider offering some giveaways.

Subleases are messy! I’ve found the most success when the rent is below market, a lengthy term remains (such as 5 years, plus), and the building is in pristine condition.

Buy-out

An owner of commercial real estate spends significant dollars to originate your occupancy. First, he sat vacant while his agent marketed the availability and searched for a tenant, all while continuing to pay the bank and operating expenses.

Secondly, that free or abated rent is another cost. Third, painting the offices and adding new flooring isn’t cheap.

Finally, he paid professionals to negotiate the lease. All told, an owner will outlay 15-25% of the lease term’s rent in origination costs! He then recoups the expense over the term.

Therefore, if you approach your landlord with the question: “What’s it going to take to let me walk?” He will surely account for all of the above.

Generally, tenants find the price too steep and opt for another avenue. But, I’ve encountered situations where buyouts make sense. Typically, a spread exists between the stated rent and the current market. A mid-term of 2-3 years remains. And little cleanup is necessary.

Term. Clearly, is the easiest, but it’s seldom used. Why you might ask? Because the ends rarely meet.

Sure, if you could time your company’s demise with the expiration of your tenancy, boom! Problem solved. Unfortunately, the dangling participle of the term generally must be severed.

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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