Monthly Archives: October 2009

Finding Deals In Foreclosure Land

Foreclosure pricing has set the tone in the residential market. While we remain in Foreclosure Land, everyone wants a bargain. This way of thinking bleeds to what was once the “normal functioning” market. Many are anticipating the same will happen in the commercial area. But whether in good markets or bad, the same thing holds true. It’s hard finding deals and it takes ingenuity to make them work. Now more than ever, a tenant is the critical ingredient in almost every purchase.

If there ever was a time for conservative underwriting standards, it’s in Foreclosure Land. We are seeing a return of risk reduction, large deductions for vacancy, and the inclusion of many line items that were neglected in better times. A few of these line items include bonus commission rates, long lease up periods, and substantial T.I. costs. These expenses can easily be 10% of the Purchase Price. Assuming an additional 2 point difference in cap rate (say from a 6 to an 8), the price is reduced another 25%. Factoring in a modest 1% rental growth rather than the previous assumption of 3% annual, could be 15% more off the purchase price. All together, conservative underwriting standards lead to a 50% reduction in the optimistic valuations of the recent past.

While lenders support conservative standards when they are making the loan, these same rational justifications are unconvincing when the banks are selling. Their hands are tied until they can find some way to take the loss. Without more capital or help from the government, the Lender will hope that market conditions improve. REO will often be a discount but not enough to satisfy the most conservative investors. A similar philosophy exists in the non-REO market.

With some properties, Lenders will look to Users because they are not driven solely by financial return. The purchase is not judged by a cap rate but by improvement to the business bottom line. Ideally, the building should have some intrinsic value because it is more functional and better located. However, too many users made the same mistake and didn’t evaluate the purchase carefully but relied on future appreciation. The mortgage needs to be in line with market rents. Otherwise, why buy? A smart User will start from the conservative investor’s mindset and add the value of the features. For instance, increased sales because of location, more productivity because of design, or reduction in labor because of function.

Perhaps the best solution is an investor with a user in tow. This combination marries a business need with the investor’s knowledge. The risk is removed from the investment, more cash can be invested, and loan terms will be improved. The tenant will see better opportunities while getting an investment return for their occupancy. The Seller receives a higher price because they are not heavily discounting an empty building. Coming out of the recession, everyone wants to take advantage of foreclosure pricing. Too many tenants lack the experience and the cash. Meanwhile investors want risk-free prices. Combining forces is a strategic way navigate the delicate terrain of Foreclosure Land.

In a similar vein, some businesses are also looking carefully at distressed Condos. With the large number of condo projects either in default or foreclosure, some local businesses are considering bulk purchases where they can house their employees on a rental basis. This too removes the risk of purchasing empty units and gives employees a better place to live. With many condo prices now at rent levels and lenders unable to absorb all the empty apartments, a business owner can buy an entire building and also give the employees excellent benefits.

We are tracking the commercial defaults very carefully. Investors want to come off the sidelines. Activity on the User side is just staring to stir. Finally, when commercial and industrial property prices start to make sense, we could be back in the real estate business. After the destruction of the last two years and the continuing fall out from the real estate collapse, neither capital, nor grave dancing, nor growing businesses are the answers by themselves. The way out of Foreclosure Land goes to those who can put all the pieces together.

Foreclosure Land

It’s late in the Summer and temperatures are hitting 100 degrees. A few people are setting up large beach umbrellas in a tall tree planter. Others are unfolding beach chairs. Someone is dragging  a large cooler full of beverages and food for the day. It’s not an unemployed broker’s beach paradise, but the west steps of the County Courthouse in Norwalk – the largest property auction of our lifetime. On an average day $30 Million of Trust Deeds are sold.  The daily street auction is unsanctioned by the government and there is no institutional oversight. Day after day, it is the lender’s clearinghouse of foreclosed mortgages  where  clever real estate buyers  stuff their portfolios full of cheap property. It’s a feeding frenzy of real estate bargains that may never be repeated.


Even though the sale takes place under tattered canvas and bidders are mostly clothed in shorts and sandals, it doesn’t mean the bidders are naive. Just the opposite. Many are armed with bluetooth headsets, tough book computers, and researched spreadsheets. The bidders are linked to their investors who have accumulated large pools of money to purchase property at 50% discounts. The sheer number of properties being sold, distant locations to underwrite, and fast pace requires competence and organization. While several websites like Foreclosure Radar and REtran  monitor the data, it’s the buyer’s experience in building, marketing, and financing that is essential.


Sales are closed in real time without due diligence. Many investors monitor simultaneous auctions in Van Nuys, Pomona and other county locations where vast foreclosures occur. Some buyers simply come to the sale with a list of properties and their top price. Others are evaluating on the fly while their associates are scouting the sites to make sure the properties aren’t damaged. While on-site bidding increases by hundred dollar increments, the investors use the precious few minutes to make final decisions.


For years, late night pitchmen showcased the money making potential of foreclosures. Most viewers felt misled because there were no distressed properties. Finally, the foreclosure charlatans have been vindicated. It’s true. There’s a lot money to be made buying foreclosures. Latest statistics show 10% of L.A. County homeowners have received delinquency notices. Still with hundreds of properties being sold on a weekly basis only a very few buyers can participate. It’s all cash at the sale and you need to show your funds before the bidding starts. On sale days, millions of dollars in Cashiers Checks are stuffed into worn envelopes, but they reside in only a few hands.


There is no competition from institutional investors. Decisions are instantaneous and although total sales volume is high, each property is too small for large organizations to analyze.  As it stands now, the best buyers are smart entrepreneurs, many from distinct ethnic backgrounds. Armenians buying Glendale, the Chinese in the San Gabriel Valley, and Persians covering Beverly Hills. A few years of this business and fortunes are made.


Meanwhile, plenty of mistakes occur. Many properties are purchased too early in the cycle only to see values fall farther. But with 50% margins, these buyers can drastically undercut the average homeowner. They are not trying to resell at the market price, but only at a profit. It partly explains the downward cycle. In many markets, pricing is being set at the foreclosure level.  While a few buyers will rent the properties and enjoy the cash flow. The majority will flip so they can redeploy the cash into new bargains. Occasionally, commercial properties are purchased, but most of the behind the scenes activity occurs  a few blocks away in the County Recorders Building.


Normally, the Recorders Office wouldn’t cause much excitement. It houses marriage certificates, fictitious business names, and voter information. Occasionally there’s an Erin Brockovich wannabe (dressed as such) investigating a major cover-up and announces the expose on her cell phone. But in Foreclosure Land, the Recorder is the source of all the loan and contact information for the lender, junior note holders, plaintiffs, and property owners. Often immediately before the foreclosure, there’s a lot of scrambling with note sales, substitute trustees, bankruptcies and lawsuits. And after the sale, the Trustee Deed is recorded by the new owner. In the past, Title Companies would simply email the documents, but with California’s ill conceived Senate Bill 133, it  has restricted Title services and many active buyers find it more comprehensive to go to the Recorder in person.  Even with Erin’s investigatory skills the trail has many dead ends because of litigation, environmental, and excess debt.


Once the property becomes bank owned, it’s generally not an immediate bargain. The bank will first try to get a price that covers the loan. Normally the price is too high and the overwhelming bet is against the banks ability to reach par. Chock full of non-performing assets, the banks become a large repository of problem properties. They are hamstrung by capital ratios because too many write downs lead to closure. At the same time holding problem real estate ties up capital and will also bring ruin. The government delays the day of reckoning by suspending mark to market accounting. TARP infusions have also provided limited stability. With additional time, there is the hope that the market improves and new capital can be raised. But as prices continue to decline, the waiting game is fraught with risk because less money will be ultimately realized. A few clever buyers are able offer the bank something of value in terms of a profitable banking relationship to help offset the loss. But it appears the end game for many banks will be failure. Once a new financial institution is found to purchase the failed bank’s assets, the new bank will  will receive a substantial discount generously aided by a loss sharing agreement from the federal government. This means the taxpayer will absorb the majority of the losses and the new property buyers will be able to finally purchase at realistic prices.  It may take a while longer, but here in foreclosure land, commercial buyers will eventually see bargains just like the bidders on the steps of the  Norwalk Courthouse.

Back to Local Markets



Perhaps I should qualify. Where there is action, it’s on the local level. Now that plentiful financing has been squeezed from the market, there is no more room for mega projects, program development, or new concepts. It’s back to basics and that means individual businesses and landlords dealing with their own unique decisions. Loans are available through SBA programs but limited to business expansions. Local banks that were not burned by sub-prime also have resources for conservative lending. The land side is virtually dead for development except under the most risk averse situations. There is however considerable activity in securing tenants for build-to-suit, but locating sites is still a challenge.

On the street, activity is at a crawl. Aircraft and defense is a bright spot but from much reduced levels as compared to the past. Warehouse and shipping is only moderate. Apparel and furniture have fallen from their once lofty highs. Business in other industrial sectors is just plain spotty.

So far, this is a much different recession than the past. There are not a lot of empty buildings languishing for months on end that sell for rock bottom prices. Very little exists in the way of bank owned property. And pricing is still holding up. Hopefully, it’s indicative of a second half rebound.

Outside of traditional farm brokerage, plant closings, bankruptcy sales, and Brownfield land sites are where bargains can be found. These large properties are scattered throughout the region and fall under the purview of professionals who have been monitoring these properties for years. It’s still an exciting part of the business although many potential buyers are now on the sidelines until financing sources return. Periods like this are great for developing new relationships.


Industrial rents range from a low of $.50 Gross to a high of a $1.00. This is the widest range I have seen in 25 years. The disparity is due to older buildings that are still in original hands compared to new developments that fully incorporate high building, land, tax and operating costs. Tenants fall equally on both sides of the divide. Some will work hard to make the older buildings functional. Others will work with high production volumes to afford the new developments.

On the sale side, prices run from $100 to $140 per square foot. And much higher in the new industrial condo projects. Surprisingly, prices are not correlated by age or condition, but by availability and opportunity. This condition is reflective of the volatility and financing dysfunction we are currently experiencing.

Availability is still low. Out of 1400 buildings in greater Gardena, only 55 are on the market. Transaction levels are down. Subleases are rising. Other interesting trends that skew conditions include continued high demand by Asian buyers enjoying currency exchange advantages; displaced property owners from LAUSD eminent domain proceedings armed with generous tax free trade money; and low interest rates for those with a bullet proof credit story.

While general business sentiment is muted, it’s not so obvious when looking at the numbers.




Gardena’s Japanese heritage has given us some of the best noodle shops anywhere. These are a few:

Sanuki no Sato has a great Nabeyaki.

Otafuku is famous for its hand made buckwheat soba noodle.

Kotohira also makes its delicious white udon by hand.

Marukai Market has a food court that can satisfy everyone’s different tastes, including a delicious fried ramen.

Spoon House is very eclectic that matches the best of Japanese and Italian noodles.

Next letter, Sushi….

Note picture at top is for the Avalon Distribution Center, now under construction. Sizes are 5,000 sf to 7,500 sf. Each unit has 2 docks, 24′ clr, and sprinklered. Excellent small distribution units. At Rosecrans and Avalon .

Industrial Property Recession

Industrial property in Los Angeles is suffering for three major reasons. Poor business conditions, an unfavorable societal environment, and a credit freeze. As these trends continue, business will be conducted under recessionary circumstances.  Meanwhile, new attention will be drawn to overcoming the current malaise by innovations in financing, industries, investors, and deal structures. Until then, it’s simple. Owners will drop their prices.

Business conditions are worsening. From last year, container imports are down 10%. This is an important factor for a region focused on port traffic. There is almost 8% unemployment. Consumer spending is dismal.  The ISM Manufacturing Index dropped to 43.5% – the lowest since 2001. We’re seeing a record number of store closings.  And of course, financial implosion. These, and other factors, directly reduce leasing and sales activity. 

Socially, the region has a host of problems that worsen with falling tax revenues. The State has a tremendous budget problem and uses short term fixes to meet legislative time frames. We have low student test scores, a lengthy building permit process, gang violence, unbearable traffic and high business and property taxes. While there are excellent pockets of innovation, once a business reaches a certain size, California loses its economic attraction. 

Credit and banking are broken and has made the purchase and sale of property extremely difficult. Pricing will come down to meet very conservative underwriting standards.  Instead of extending credit, many lenders are calling their loans. This requires investors to post more cash to meet revised lending standards. SBA loans are available, but buyers need to weigh higher mortgage payments and declining prices against lower rents. 

Recessionary negotiation tactics are back: Free rent to maintain a high base rent.  A secondary market to fund tenant improvements for broke developers. Assumption of existing leases to induce tenants to move. Full fee and bonus commissions for brokers. Abundant cheap sublease space competes with direct lease space.  Property tax reductions   Landlords renew leases at lower rents for longer leases. Owners will deal based on their personal bottom line and not on “market” rents.

For purchases, loans will be calculated on market rents and not the resale market.  Replacement cost will be a misleading indicator as both construction and land costs decline.  Cash starved sellers will entertain options, participations, financing, and other creative structures.  Many wealthy families that have been on the sidelines for the past ten years are returning to the scene to realize superior cash returns.

On the brokerage side, everyone agrees that business is slow. Listing Agents are succumbing to Tenant Brokers who will bargain mercilessly for their client. This role reversal leads to an abusive atmosphere that is characterized by concession fervor – obtaining as many tenant perks as possible. This zealousness is not unlike some landlords who were just as larcenous by passing through every conceivable and creative line item they could justify. Unfortunately, when markets change, payback is justified.

Many tenants will comprehensively shop the market only to make the best deal where they are.  With leasing competition so intense, every landlord will exert themselves to snap up any live body under any halfway reasonable scenario.  Meanwhile, brokers are so hungry that no tenant will be left uncalled bearing offers to beat any deal that is under current negotiation.  When markets are in free fall, participants act like it’s a free-for-all. 

There will be unusual leasing circumstances. Poor credit, unsavory characters, short leases, and undesirable uses will be a few.   Building Sharing, a relatively common occurrence in the logistics area, will become more widespread as tenants seek ways to reduce overhead. 

Innovation will spring from desperation. Without the mania of securitized lending, buyers will need more cash.  As Wall Street hegemony vanishes, investment partners from local sources will be sought. But funds won’t come cheap.  Using Warren Buffet, with his recent investments as an example, investors will want 10% and a share in the upside. But only for “A” deals.  Investors will clamor for significantly higher returns for the typical Los Angeles industrial property. 

With financing scarce, not only will the broker need to find the deal, but he’ll also need to procure the tenant before closing, except in the most distressed situation. The broker will need to do twice the work “on the come” before being paid.  In this pre-lease atmosphere, users will gain control of the market.  Investors, for empty buildings, will need to take out such large deductions for leasing risk, marketing carry, and fees, that their offers will be undesirably low. 

Tenants will be helped by being very specific about their needs. For example, the most modern distribution buildings  come with  high rents and property taxes. Since many buildings were purchased by institutions under the smallest of margins, there is a not a lot of negotiation room.  However, if a tenant can use a building that is less functional, they may be able to find one that is in older hands and considerably reduce their overhead.  

Joseph Schumpeter, the great economist of the 20th Century, taught that after economic destruction arises strong creative forces to start the next business cycle.  Leaders will come from the entrepreneur class, a very dynamic group in Los Angeles. Companies such as SpaceX and Tesla Motors may be the renaissance of the region’s great aviation and automotive tradition. Several local apparel companies, like Forever 21 and American Apparel, are creatively combining both vertical manufacturing and retailing while many of their competitors are quickly retrenching.   The City of Los Angeles’ CleanTech Redevelopment Project on the former 20 acre Crown Coach Property is the first of several industrial projects that will incentivize “green” manufacturing businesses.   Likewise, Cal Poly has set aside 65 acres for its Innovation Village that seeks industries of the future. 

While the pain is clear and solutions will be difficult to implement, a region like Southern California will always have opportunity. First we need to deal with the present. But innovation, team work, and hopefully, capital, will lead us to the best buying environment of a lifetime.

                                Clean Trucks Program

The Ports launched their Clean Trucks Program earlier this month. It bans older trucks (pre-1990) now and all others must meet 2007 standards by 2012. While the sentiment may be right, the timing is bad.  The logistics industry is slumping and one major mechanism to finance new trucks was vetoed by the Governor. Many truckers can’t afford to comply.  Unfortunately, this is a common problem while trying to green in a recession.

Rents for truck yards are falling. Recently there were no sites, now there is no demand. Many feel if Clean Trucks remains law, larger trucking firms will acquire the smaller firms to gain oligopolistic pricing control. In this case most large truckers will want cross dock buildings with large parking lots and ordinary truck parking sites will no longer be needed. That is, if we still have a thriving trucking and logistics industry when the recession ends.  


Avalon and Rosecrans, Gardena, CA – 8 Double Dock-Hi Units – 5,000 sf to 10,000 SF  – Available November, 2008..



At the Edge and Stagnation of Valuation

The business of real estate is close to an end. Developing, investing and lending have all halted except for the most secure or distressed situations. An enormous swath of the industry is mothballed like an auto plant in the summer. Just like autoworkers, real estate practitioners are wondering if production will re-open. Lending divisions, development companies, land developers, and acquisition departments are closed until further notice. The biggest fallout is people we have all known for many years that are deciding what to do for the future.


There is still a small user business but most tenants are staying put until they can get a better picture of the future. Many companies on survival mode are looking for ways to finance their ongoing operations. Expansion is a distant thought. Industrial Los Angeles is suffering from the transition away from manufacturing to an industrial economy reliant on warehouse and trucking. Without consumer spending, the entire warehouse industry is bringing down industrial property as the remaining truckers seek lower marginal rents to remain profitable. Consolidations are rife as many transportation companies give up their own buildings to contract with the lowest cost 3PL.


There are a few cost saving stories as tenants migrate from expensive Westside and LAX to lower rents in better South Bay space. A similar trend occurs with companies exiting Downtown to points east or south. Instead of looking for businesses that are growing, the action is on the shrinking enterprise. Another small area of business comes from Asian companies. As American industry declines, Asian companies are expanding into beachhead opportunities they can exploit with better engineering, finance, and hard work. Hopefully, as finance fails to offer satisfactory positions to the brightest minds, we’ll see a renewal of American ingenuity into other productive fields.


In terms of the market picture, those owners who can offer cut rate pricing will do so to fill their buildings. Many rents are now below inflation adjusted numbers from the last real estate recession of the early 1990’s.  Others who are stuck with high debt service are in the unenviable position of feeding the flame in a period of declining pricing. Soon it will only make good business sense to stop paying the mortgage and attempt a bank workout. On average, asking rents vs. asking sale prices are wildly out of whack. 


Valuation Stagnation:


A common thread talking to brokers is they have no idea how to price property. Sellers are still holding on to the old hope of selling in a market of increasing comps. While these Sellers realize that dream is over, they still benchmark to a User world where rents are not as meaningful as appreciation.  Buyers are looking at pricing from the bottom. They use an income approach assuming the worst will happen. This means a 10% cap on declining rents with large reserves for leasing, T.I.’s, commissions, and vacancies. The difference is almost a gap of 50% and this explains why there are no deals.


Unfortunately for brokers, velocity suffers and the lack of transaction volume is exacerbated by the banking mess. While many buyers are salivating over foreclosures to come, bankers are willing to roll over problem loans to avoid taking the hit. As long as there are minimal cash flows, government loans at 0% can help banks play the short term rollover game. Suspension of “mark to market” accounting rules is another reason why non-performing loans are not being recognized.  With many developers on the hook with personal guarantees they have no choice but to play ball and send all the rents and sale proceeds to the bank to reduce their outstanding balance. Another government backstop helps the privately financed bank mergers. As long as the US is willing to guarantee the majority of losses, the new breed of bankers can focus on generating deposits while letting their “bad bank” colleagues engage in the dark-side of real estate workouts.


We will see plenty of capitulation on an individual scale. But with all the federal dollars, guarantees, and negotiated sale prices being offered to the most desperate institutions, we’ve created zombie lenders who have no motivation to foreclose and bargain out their properties. However this condition also prevents the lending of fresh money because the underwriting standards banks are using for new loans is the complete opposite they use for their existing, defaulting borrowers. Until we reach a cathartic moment like a GM bankruptcy for the commercial real estate business, there will be no discernible level to promote transactions. We will all be limping along with short term vision.