Monthly Archives: October 2006

Added Value Property

 

Creative solutions to problem real estate are the domain of value added deals. These are buildings that after they are redeveloped will increase cash flow and operability. The simplest examples are adding more square footage to an underutilized land area or subdividing the building for smaller tenants at a higher per foot rent. Because building new is so costly, there is more attention being paid to reconfiguring older property.

As business changes, buildings need to adapt. The new breed of companies in the Trade Triangle – the area between Downtown markets, the Harbor and LAX – want convenience to labor, transportation and talent. These businesses are small, fast, and ethnically diverse. They trade and source on a global scale. Their products and services are  information laced and branded; technology is a key component. Speed is a must. Close-in locations are required for physical interaction with customers, suppliers, and employees. A lot of the industrial building stock is left over World War II and later. These buildings served a different purpose than what is needed today. While many teardowns exist, the high cost of new construction makes reusing existing more economic sense. On a limited scale, a few developers have created some very successful prototypes, most notably in Culver City. Now the concept is spreading through the rest of Los Angeles.

Lighting, landscaping, additional windows, open offices, outside areas, new demising walls and flexible design are a few of the minor improvements. Total reconstruction will be the next stage of reuse. Buildings will become places instead of locations. In many cases these buildings will no longer serve traditional industrial purposes. Areas near cultural amenities like Asian influenced Gardena, Hispanic inspired Pacific Boulevard, or Downtown adjacent will have the most appeal. Creativity, lifestyle, bonding and deal-making are large components for new business models.

Sometimes these buildings are listed. Mostly they appear on quietly traded channels like a broker’s private mailing list or party-to-party direct deals. The computer multiples may be a limited source but it’s overwhelmingly a vehicle for user sales and leasing, not value added investor deals. Many of the best buildings are held by a fairly small, sophisticated group of investor developers and their advisers who truly excel at the real estate business. Mostly, it leaves intelligence, hard work, and a little luck as the primary method for finding properties to add value.

There are tools that the experts use. Financial models, site plan studies, extensive re-construction estimates, and market studies are a few. Each lease, credit, dimension, improvement, and repair is negotiated and scrutinized. Finally when owned, the best examples will be well managed properties with new signage, shared loading, good space dimensions, amenities, common areas, maintenance, and location. For all but the most seasoned professionals, the value added proposition is difficult because extraordinary skill and patience are required. Of course, the result is a testament to the deal maker. And for the experienced real estate person, the achievement is equal to the financial reward.


Valuation

 

 

 

In many cases traditional methods of valuation – comps, income, and replacement – are no longer guides for pricing property. Sale prices often exceed most traditional justifications. Properties sell with cap rates that are below mortgage rates so the buyer is already starting in a negative position.

Unless the buyer can add value quickly or factor in appreciation, these are not good financial purchases on paper. The shrewd economic justifications only become clear once escrow has closed and the property has been put into use. Here are a few explanations: Los Angeles is a global crossroads and some properties have international dimensions. These properties are not compared to comps locally but internationally

This is especially true if the Los Angeles site is meant to fill a link in a global chain for distribution, production, or sales. In that regard, what some consider overpriced may be a bargain, especially if you include foreign exchange rates. Other locations are analyzed by the sales they generate. Retailers or quasi-retailers value the site in part by traffic and the amount of goods that can be sold. Many industrial brokers and owners miss the retail component of their building. Los Angeles changes so fast that unless you have a retail eye, it’s easy to miss the demand caused by an expanding population.

Los Angeles has a number of micro markets for trade and ethnicity where pricing is higher than the rest of the city. Examples include several downtown markets for merchandise and a wholesale district near Vernon Avenue for “cash and carry”. There are many ethnic communities that cater almost exclusively to people from one foreign country. Real estate prices increase closer to the center of these communities, but only an insider can discern the difference. Zoning adds another dimension. One simple example is how an old industrial site quadrupled in value when the city changed its zoning to residential. As all cities face housing constraints there continue to be enormous increases in value due to zone changes. Land values around redevelopment areas also exceed market conditions.

Finally, professional investors have a second sense when it comes to recognizing potential. Some use patient money with a long horizon. Others use proceeds from past deals. Some take calculated risks based on many years of investing and developing. Key parcels are particularly intriguing because the buyers understand the extra value associated with these properties. Basic underwriting is still fundamental. But buyers who use traditional methods to value real estate will be at a loss compared to those who have a breadth of contacts and experience to understand very local markets and new product types. As Los Angeles continues to grow, buyers of property will need to take greater leaps from fundamentals if they want to continue investing. While real estate cycles may signal bargains from time to time, the overall demographic nature and the intelligence of shrewd investors will be a constant.