Relocation advice for transitioning companies

In various columns, I’ve 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.

Business transitions include 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.

Last week, I met with three such companies all of which were 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. Of concern was the new business owner ran the day-to-day differently. Could the rent be replaced if the group bolted?

The real estate was quickly sold and three investments were bought through a tax-deferred exchange. 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 the going 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 rollover 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 canceled.

After the buyer exited due to all of 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. The 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 bought their business property in 1995. In the ensuing 25 years, exponential appreciation had occurred. By their admission, the address was worth three times the value of the business it housed.

Finally, a suitor for the company had gained favor, and 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 the 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.

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5 ways your offer can stand out in a hot industrial market

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 nearly 80% complete. Costco has Christmas decorations in stock, and socially distanced Halloween isn’t yet a memory. What? You’ve not yet strung your lights? But, I digress.

Since January, we’ve seen 15 sales for industrial buildings greater than 50,000 square feet within the Orange County’s 34 cities. These from approximately 868 existing units in this size. Excluded from these statistics are lease transactions – another conversation. But, in 2020, suffice it to say, 15 sales, 868 buildings 50,000 sf and larger – 1.7% of the base inventory sold.

Now, how many 50,000+ sale availabilities are there? Care to hazard a guess? If you guessed five, you’d be spot on. Viewed another way – only a bit more than 1/2 of a percent (five available out of 868 existing structures) 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 have 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 sales market. Sure, you can consult with your banker and get pre-qualified, which, by the way, is 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 25-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 sales arena, the back story is critical. We came in second last week. Second is the 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. Also, we were prepared to offer the asking price and no one could touch us.

Intangibles

In the previous examples – intangible factors existed – a 25-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 a 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 can be structured. How about adjacent states of Nevada, Arizona or Oregon? We’ve witnessed several occupants exit 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. 

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Got a vacancy? Here’s what to expect in a commercial real estate marketing report

Some of you reading this column own a company that occupies a building you also own. Others are involved in some facet of the commercial real estate profession – a broker, lender, architect, escrow holder, title officer, or contractor.

Still others might own a strip center, office building, or small industrial condo from which you derive monthly rent to supplement your income. (Hi, Rudy.)

Regardless of your angle – you’ve been on the receiving end – or have prepared – a marketing report. You see, when a vacancy occurs, a broker is hired to find a tenant or buyer for said vacancy. That is, of course, unless you choose to go it alone, which I strongly discourage — but I digress.

What information should expect from your broker in the report? I generally like to update three specific areas. Akin to a microscope zooming in – my reports start with the overall market conditions and zero in on specific recommendations for the assignment.

Market activity

The market in which your vacancy competes should be constantly reviewed by your commercial real estate professional. Let’s say you own an industrial building of 100,000 square feet that is 10 years old. How many spaces are available? What are the most recent comps? Speaking of comps, are they mainly sales or leases? What active requirements are circling?

Based on all of these data points, market conditions emerge from which decisions can be made. As an example: If you’re attempting to attract a tenant and the vast majority of recent activity is from buyers, you might consider altering your plan.

Conversely, if your asking price eclipses the market sales, you better have some staying power to allow the pricing to catch up. But if you find yourself in a downward trending time, you may wait a very long time.

Active interest

Who has inquired? Are they kicking tires or is there some motivation for their search? I try very hard to find out specifically which company is represented, what else they are considering, and why our building may or may not work.

Next steps

Fresh coat of paint? Add an office or two? Freshen the landscape? Lower the pricing? Offer some owner-carried financing? Offer something that others can’t — an option to buy as an example. All could appear in the recommendations to an owner of commercial real estate.

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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Can 2020 get ANY crazier? Here’s a commercial real estate metaphor

Commercial real estate was business as usual with no recessionary storm clouds massing on the horizon. The drought was behind us, too, as we continued a relatively wet winter. Local sports teams were finishing strong. What was ahead? The opening of Marvel Land – Avenger’s Campus at Disney’s California Adventure. Summer vacations, kids starting their spring semesters, anticipating graduations. June weddings. Breaks in the work schedule to celebrate birthdays, anniversaries and national holidays.

Yep, that was our view of things to come back in January 2020.

But, in the ensuing gestation period, 2020 has eclipsed any year in recorded history for weirdness! Pandemic, 208,000 deaths, worst economic recession since the 1930s, upheaval in the streets, absence of civility in our public discourse, hurricanes, wildfires …

And just as we believed we’ve seen it all … BOOM! Our president and first lady and a host of their close encounters have been stricken by the hidden enemy – COVID-19. I’m not certain 2020 can get any crazier!

So, is 2020 somehow metaphorical for commercial real estate transactions? Maybe! Indulge me while I develop the conversation a bit more.

An unexpected turn

Purchasing commercial real estate for your business remains a great way to build legacy wealth for your family. I speak with many closely-held company owners who’ve created an entity to own their acquisition and then leased the purchased real estate to their corporate operation.

Some boast their locations are now worth more than the companies they host. Occasionally, I encounter the opposite – akin to the start of 2020 and what followed.

Take, for instance, the aerospace manufacturing group that tooled parts for jetliners. Things were peachy and operating from an owned location. Revenue was growing; the facility met their needs; commercial real estate was appreciating; many were employed; life was grand — until it wasn’t.

You see, although the owner of the business and real estate were similar, they were not a mirror image. Upon the untimely death of the founding patriarch, all manner of chaos ensued. Unbeknownst to the business operator – the son – title to their company site had been deeded to seven factions with disparate goals. Some wanted money, others needed money, while still others realized absent the building – where would operations continue?

Things got very ugly.

I’m pleased to report the aerospace firm is happily domiciled in a leased location and the building was sold. Oh, and that 2020 will end happily as well.

It really boils down to risk. Our president contracted the virus. Many test positive yet are asymptomatic. Was it a blatant disregard of safety protocols – masks, distancing, sanitizing – by a purported germophobe or simply a random occurrence? The arguments on either side are as numerous as viruses in a petri dish.

Suffice it to say – risks were taken. It may end badly. We pray not. Are there ways to minimize risk? Of course! Stay home, follow the guidelines, avoid human contact. Done. Sadly, many adopt a riskier approach – much like driving in and out of the fast lane on the 405 and exceeding the speed limit all while eschewing a safety belt – you’re increasing the odds of a catastrophic outcome.

How to avoid risk

Buy a building – at a safe social distance, no less – at cheaper than market comparable sales – for cash – no loans.

Plan to occupy it with your business. If you don’t own a company that can pay you rent – forget about buying commercial real estate. If you divest yourself of the company – sell the building as well.

Pay the taxes. Bank the profit. Done!

I’ve just described 3% of commercial real estate owners. The remaining 97% tend to take a bit more risk – albeit for a potentially greater return. Tantamount to playing Twister in a tsunami, the risk doesn’t have to affect life, limb or the pursuit of happiness – although some invest that way.

Examples of “going without a mask” in commercial real estate might be: borrowing more than the property is worth; buying an unsustainable income stream; investing in a special purpose building. You may end up just fine. Then again, you may have to quarantine for 14 days and hope for the best.

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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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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