Category Archives: Los Angeles

Questions About The End of California Redevelopment

We are starting an extremely interesting and confusing period as redevelopment agencies (RDAs) come to an end. Firstly, RDAs were a powerful force in every city’s arsenal. They employed large staffs and had enormous budgets. A lot of the built commercial world is attributable to redevelopment through direct land contribution, infrastructure, subsidies, guarantees, loans or other physical or financial contributions.  RDAs created a lot of very good development that would not have otherwise been built. High quality, low income housing units were developed.  Many private and capable developers profited.

Legislation (AB X1 26) that allowed for redevelopment’s dismantlement appeared as if it were a minor line item in the Governor’s budget.  Many redevelopment  professionals did not take the legislation seriously. Many staff members at the RDA’s had a sense of their own special value and mission. With the weapon of eminent domain at their disposal and a large war chest of tax increment funding, RDA’s had enormous power if they wanted someone’s property. Attorneys were always available to defend RDA actions. The only remedy for a disgruntled private party was to obtain a better valuation in front of a judge. This same sense of entitlement led the RDAs to court in order to challenge AB X1 26 instead of negotiating with the Governor for a share in the tax increment. But the RDAs lost and the Agencies are now gone.

But what is not gone are the hundreds of projects in various stages of completion and an enormous financial obligation to pay bondholders that financed these developments. The biggest question and greatest complication is that there are no detailed rules that can be used as guideposts. Only the barest instructions are available and they mostly consist of the institutional framework and not the details of dismantlement. In other words each RDA has flexibility to wind itself down as long as it meets state oversight.  Many cities have decided the risks of administering the end of their RDA is too great and have abdicated the responsibility to the state. Los Angeles is the largest example. Nelson Rising was selected yesterday to be part of the three person panel to unwind the Los Angeles RDA

I took a look what the RDAs own in Los Angeles County. I counted almost 2500 parcels of land. Some parcels comprise one project area but it is an enormous amount of property. Many of the sites are in very valuable commercial locations or are perfect for multi-family development.  By next week I should have it mapped out as a feature layer on my MAPP program.

Will the vacant properties be sold if there is no agency to manage them? Will the proceeds for the land sales be needed to offset bond obligations and administrative costs? What kind of conflicts of interest will be created by the selling agencies? Who will be hired to evaluate and dispose of the sites? What is the future of subsidized development? Will new city agencies be created or will exisiting ones take over the redevelopment mission in another form?

I have already heard from a few clients that they are eyeing certain properties. The same developers who already partnered with the RDAs and have proven capabilities are in the best position to purchase these properties. It is after all a very small world when it comes down to the final short list.

Order can be brought to the disposition process. The ideals that led to redevelopment can still be preserved as properties are sold. However the challenge is enormous because of the large number of sites, the value of the properties, and the clunkiness of any disposition apparatus on this scale. Unfortunately, many cities and government agencies that have operated by weak legal standards or lax oversight in the past may be tempted to dismantle their RDA’s in the same manner.

We are just at the beginning of the process but I expect it will heartbreaking to many and an opportunity for some. For readers that want a better understanding of the end of California Redevelopment, one of the best sources is The California Planning & Development Report. It makes their publication essential reading.

HOW ARE THINGS LOOKING?

 

Customers always ask me, "How do things look?" Here's one way to answer.  In this roughly one square mile grid of Broadway/Rosecrans, there are about 120 buildings of decent size. I count 25 that have availability. Perhaps not the entire buildings are on the market, but enough to depict this picture.  That's about 20% of the buildings with significant availability. I'm working on a lease in Chatsworth and there is even more yellow. This is  a pretty consistent picture throughout Los Angeles.  In contrast, there have been times when there is no yellow.

On a transaction level,  Landlords need to swallow a lot of pride to make deals. Rents are substantially below what anyone ever anticipated.  Tenants are negotiating hard.  On the sale side, and this is a surprise, some prices are much higher than one would expect based on rents.  The high ceiling, good-loading gem boxes are selling and mostly to Buyers who can take advantage of the cheap dollar. Older manufacturing buildings, like those found here, have not shared in the price recovery to nearly the same degree.

While activity is perking up slightly, it's spotty and unsteady.  In my case, I get a small run going and all of a sudden it's cold again. Likewise,  my broker friends may make a big deal, but then the spigot turns off.  Fund activity and build-to-suits are the source of considerable focus, but getting inside those deals are challenging.  Finally, there are some great land pieces all across Los Angeles, but it is still the most risky of all categories.

Overall, the picture is very uneven but as we move towards the rest of the year I expect to see less yellow on the map, and hopefully, more green in our pocket.




 


The Port Strategy Fallacy. It’s the Deal That Counts.

 

Both brokers and investors tout the strengths of investing in markets with a vibrant harbor and airport. This has been a pronounced strategy from at least 1997 when container imports began increasing beyond incremental growth. Many institutional investors have dubbed this the Gateway Strategy. But grand proclamations like these normally lead to increased competition amongst buyers and lower returns. If history is any lesson, the money was made by the first round Buyers who purchased these distribution buildings at distress. It was the following group who used port dynamics to justify their high purchases and are now sitting with vacant and poorly leased properties at rents vastly below proforma. In retrospect, it was the deal strategy that made investors money. Being located by the port was secondary. 

The Port Strategy became a marketing ploy that led to an enormous exaggeration of demand. It becomes evident as one moves further away from the Harbor, through the Inland Empire, to Las Vegas, and as far away as Phoenix. This is the route of the west coast warehouse boom, and unbelievably, developers actually marketed warehouses in Arizona as Los Angeles Port locations. It may well be that just as we saw de-industrialization occur in the 1980's, we will soon see de-warehousing along interstate routes of 10 and 15.
 
Ports do bring activity to areas that receive incoming merchandise especially in contrast to declining Midwest industry. But as consumer spending slows, the need for warehousing  diminishes. An expanding population will lead to moderate growth, but no longer to the levels predicted from the container volume boom. We've already experienced the impact from surging from Chinese production. Buying again into the port fallacy will need to wait for better evidence.
 
To make matters more challenging around the Los Angeles Harbor, many investors need to compete with an extremely large property owner who received vast tracts of industrial land for free when in service to the King of Spain at the founding of California. Normally, when there is an abundance of activity, there is enough absorption for everyone, but in a down market, the "low basis" landlord fills up first. Factors to today's leasing market has a very historical precedent. 

Likewise, students of current history will look to this period as the day of the individual deal. Finding property in these deep recessionary conditions takes place one property and one user at a time. Investors will count heavily on brokers because of the hard work and relative scarcity of opportunities. Many searchers are armed with sophisticated database and web tools to weed through broad swaths of the greater Los Angeles market. This year there have been a couple creative deals where large investors have purchased hulking, junky buildings at land value. They are able to enjoy a fair current return with bottom-of-market rents, while land banking for future development.  Another example is a breakup of a large manufacturing plant that had its component parts sold off in pieces at a profit. Mostly however, until lender forbearance wanes and bankruptcies wind their way through court, most investors will need to dig harder or look for another profession.

In the "B" market where I find myself most of the time, $.35 NNN rents conservatively equates to an investment purchase price in the high $40's and so far those types of deals are not available. If someone has a higher value estimation, we may be able to do some business together. Conversely, Users can find some opportunities in the low $60 level. I've  seen a few building examples where the mortgage payment is not much higher than rent. Plus a business can establish a permanent home with all the ancillary benefits of creating a Place. There are some excellent properties on the market that Buyers would have fought over in better times. Needless to say, the lease deals are great.

If you like the hunt and are not burdened with excessive debt this is an excellent time to look for property deals. But be careful of any stories that go with the offering. We are in a period of extreme fundamental analysis in a market that can easily decline further.

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.

Container Freight Volumes Decrease

 

 

If there is one major driver that supports Los Angeles Industrial real estate, it is counted by container shipments that enter the Ports of Los Angeles and Long Beach.  These shipments are singularly responsible for the development and leasing of large blocks of high-cube industrial space. When goods are flooding into the ports, industrial building development booms throughout Southern California.

Every major landlord and developer points to the Harbor to justify their building growth plans. Now with container volumes on the decline (although from a very high level), longer space absorption will become a significant factor in analyzing future planning. It will just take longer to lease those buildings.

New buildings will continue to be attractive as companies leave older “B” and “C” warehouses. There is always a migration to better product when leasing conditions begin to soften. Older and obsolete buildings suffer, but new developments will also miss their proforma targets. Unfortunately, for now, manufacturing is not much of a substitute as a major source of replacement tenants.

All industrial real estate practitioners will continue to keep their eye on import flows along with consumer spending and cash-out mortgage refinancing. This linkage has given us a great market. Now we’ll be paying closer attention to these important indicators as we look to the future.

(Chart from WSJ – 3-20-2008)

Many of the leading brokerage companies and economic forecasters are currently quoting vacancy rates of industrial space at 1.5%. I’m not so sure it’s still true. I looked at a small sub-market where I have had some experience over the past 20 years and have found availability rates are higher than many may think.

Firstly, Gardena is a fairly central market to greater Los Angeles. It’s located approximately 15 or so miles from Downtown Los Angeles, Beverly Hills, Palos Verdes, and the Major Ports of Los Angeles and Long Beach. The Gardena vicinity also includes parts of Los Angeles City and unincorporated Los Angeles. This location is central to the Los Angeles economy. Buildings generally date from the 1960’s to 1980’s.

I have found an overall availability rate of 4.7% from a base of approximately 17,500,000 square feet. From the 800,000 square feet now being marketed, a couple of size ranges are increasing. While we are still at a fairly benign rate of availability, and with only 18 or so buildings being offered, these are not alarming statistics. However, as your doctor may say, well worth monitoring, especially in the range of 40,000 sf to 60,000 sf.

We’ll be looking at some other areas throughout Los Angeles to see where vacancy rates are headed. So far dire financial news has not struck too badly at industrial real estate, but most of the optimists are having trouble raising funds.

PDF of Availability Stats. Underlying data also available.

Be Nice To Your Tenant and Industrial Lands

 

 

The market has shifted and building owners can’t act like they are solely in control. It’s not that vacancies are so high, but business expansion and leasing activity has reduced to a crawl.  Many tenants want to stay put and extend their leases until business comes back. Smart landlords are willing to grant these short term extensions rather than have an empty building.

The fervor to purchase has long subsided except for those who are looking for the deal of the century.  Container volumes from the ports are no longer growing. Manufacturing is stuck in a morass. Many space users in the apparel and furniture industry are wary of the twin concerns of low consumer spending and the crackdown on undocumented workers.  Contractors and building material companies are not finding customers.  These are some of the factors that explain the slow leasing activity in industrial Los Angeles.

Up until recently it has been such a bullish Landlord’s market that many owners have forgotten what it takes to make a deal. Many are stuck in uncompetitive positions because of high financing costs and fixed operating expenses.  Some big owners have long relished their place at the top of the pyramid but are quietly talking about slow paying tenants and working with weak credit tenants. In terms of carrying vacant buildings, the cost is all on the Landlord, so tenants can take plenty of time looking for that right situation.  Absorption is the owner’s primary concern.  Even valuable option rights may be granted under the right circumstance.

Since leasing conditions will weaken as the financial crisis plays out, more landlord concessions are on the way.  More “B and “C” buildings will become vacant as tenants gravitate to newer buildings.  But tenants should be careful about getting more building than they need in terms of loading doors, ceiling heights, and yard requirements.  Eventually leasing costs will catch up either by automatic rental increases or a returning market.  Now will be a good time to use lease comparison software to make sense of different alternatives.

Landlords will need to do more to keep tenants happy and attract new ones. Many have seen this cycle before and are well positioned to offer the necessary incentives to rent their buildings.  Most owners can quickly calculate what it costs to keep an empty building and this can add up to a nice allowance for a worthy tenant.  One area that will be more difficult than past recessionary times will be the amortization of additional improvements. Sources to borrow these funds are hard to find and that will be a non-negotiable item in our credit impaired times.

The Landlord business will shift to management, tenant retention, and lease negotiation. There will be less emphasis on scouring the market for deals as there has been over the past several years. Owners with superior personal skills and buildings with unique characteristics will be meaningful as intangibles contribute to leasing decisions.  We’ll soon see who are the true real estate experts.

Industrial Lands Project – City of Los Angeles

January 5th, 2008

Los Angeles Industrial Zones

The City of Los Angeles released their extremely thorough report regarding industrial land. They discovered that much of the industrial land is disappearing to other uses and the goal is preserve what little is left. The new study focuses on Downtown, West Los Angeles and Hollywood.  Except for selected pockets, residential development will be strongly discouraged.  From the city’s perspective, industrial land is the source of good employment, tax revenues, and the possible location for new green industries. It’s hard to argue that preserving industrial land is not important.

However, many people are extremely angry including property owners, developers and City Council members who represent the impacted districts.   In many instances, burgeoning communities, in formerly blighted areas, will be thwarted by these policies.  The City points out that land speculation in these industrial areas has been rampant with developers gambling that they will be able to obtain lucrative zone changes to build housing. This has made it unaffordable for industrial tenants to locate in these industrial areas. The new directive will establish firm guidelines to correct the loss of industrial property.  Or will it?

The City is a large island in the sea of Southern California. When industrial users look for locations, they normally don’t single out a particular city, but will consider several areas. While vacancies are currently tight, space availability is cyclical and I expect to see more empty buildings as the probable recession mounts.  In addition, there is a natural industrial flow where production with higher valued inputs stays local, and companies that search for a lower cost position move to the periphery or overseas.  When examining the specific industrial locations the City has identified I can see their concern, but business will find a perfectly good building to occupy in the region.

One alternative is to allow development in the controversial areas and use the new tax revenue to improve the 270 acre Goodyear Tract that is in dire condition. Annexation of such County areas as East L.A., which contains another awful industrial area, can use considerable investment.  The City of L.A. could launch a competing offer than the incorporation that is presently proposed. Local companies will fight the additional business costs, but if property values rise and industrial companies can switch to more dependable electricity from DWP, that will assuage many concerns.

The new land use policies look rather draconian because of how blocks of industrial are being differentiated, especially when many of the new projects are offering real improvement and lifestyles that are in keeping with the post-industrial future. The saddest thing about the land use policy is if the conjunction of Little Tokyo, the Arts District, light rail development, the Los Angeles River and new entertainment centers is damaged.

Planning and CRA have presented this plan as a fait accompli. City Council persons and moneyed real estate interests are not happy.  It almost seems that the preservation of industrial land is a lot like the argument that was used to keep auto and steel jobs in the U.S.  Based on that, I’m betting on development.  You can form your own opinion, http://cityplanning.lacity.org/ .    

(The above map from the City Report) 

Things Are Changing……

 

 

Everyone has an opinion about where we are in the real estate cycle. Home builders and residential lenders see this as a crisis. Commercial brokers nationwide talk about a slow down. Just this month I have seen a lender take over negotiations in a land sale, a substantial money default on a development deal, and a newer investor unable to replace his interest only loan. We are also receiving calls from sellers who passed on our “low” offers earlier in the year and a few landlords are complaining about tenants getting behind in their rent. So far, most of the problems are related to financing and over-optimistic projections. Still, this a lot of personal incidents in a short period. 

The Los Angeles industrial market is holding, but volume is down.Sale prices are reasonably stable and gross rents have been increasing.  Vacancies are low.  At this stage, many are distinguishing between financing and general commercial real estate markets. For those who rely on significant borrowed money, they feel the crunch. Owners with only a modicum of debt are in an enviable position. A robust user market in Los Angeles provides a comfortable cushion for most owners. Partly, we are seeing a financing transition with the levered structured loans being replaced by foreign investors, better operators, and old time conservative investors.  It will be rocky until valuations get to more traditional underwriting standards.  Too many deals were underwritten on lofty sales projections and prices will be marked down using current rental values as the benchmark. Differences between Institutional  and non-institutional grade will become more pronounced as top tier capital flows to Grade A properties and there is a free-for-all for everything else. 

Until recently, lenders were forking over 95% loans for development deals. And while hurdle rates were based on rapid sales velocity, these developments were successful because of so much liquidity. It was never a question of money, but of finding the deal. Now we are entering a new regimen that will emphasize prudent investing. Other highlights will be more emphasis on tenant strength and more equity as a requirement to receive favorable loan terms. Cash investors will find long sought after yield. Build-to-suit deals will return.  Brokers will become more valuable because of their marketing skills, tenant relationships, and deal-making ability. 

 


 
The Importance of Brokerage 

It’s no longer an opportunity-finding business. Brokers will need to be more active among lenders, buyers and tenants.  Making the deal will be a necessary service. Proforma skills will return, especially in the areas of contributed cash and partner returns. Lenders will want more proof that the deal works. Build-to-suits will replace spec construction. Brokers will need to pay more attention to design, construction and financing. Regional knowledge will become more of a factor because tenants and buyers will consider a much greater geographic area to find bargains. The broker’s personal network will become wider. Leasing and sales will require more effort.  Broker’s who can direct traffic among tenants, financing, and property will continue to be successful. Forthcoming conditions will weed out many brokers who only provide a property list. 

As it has been, many buyers crave off-market deals because the multiples and auctions priced property too competitively. In continuing fashion, many lenders will want to sell as quickly as possible to avoid write offs. If conditions become reminiscent of the early 90’s, sellers will take any reasonable price for a quick close. In addition, on the market properties may also be fruitful as they have not been recently. Some sellers will want to use all avenues, but it will become a Buyer’s market because of cash shortfalls. Strategy will also play a role. First mover advantage will no longer be important as many buyers will wait for a perceived bottom. Character will also matter as many unscrupulous buyers begin to surface in uncertain times.  


 

A Tenant Revival 

Although vacancies are still low, financing will require good tenant leases. Appreciation will no longer be a replacement for poor leasing. Still tenants will need to recognize we are in a bifurcated market. In class A industrial buildings, tenants will have limited alternatives and they are being required to pay “all-time” high operating expenses. The lower grade buildings will be opportunities because this is where the credit crunch is more harshly felt. These are well located and functional buildings but are older, have lower clearances, and fewer loading docks. As U.S. exports increase, these non-institutional grade properties will become value plays. Land will also be fruitful because  leases will drive new developments in greenfield and the occasional infill piece that surfaces. 

Some tenants may also be able to buy an ownership interest. Many developers will gladly have tenants as partners if it results in a deal. Typically, the owner takes all the risk and the tenant has maximum flexibility subject to lease terms. In this scenario the tenant pays the entire cost of ownership while they are occupying the building plus a return to the owner.  When the lease term is over, the owner hopefully receives the building back at an appreciated rate as a reward for taking the real estate risk. As financing becomes harder to obtain, some investors may seek tenant partners will share the rewards of ownership. This mutually beneficial arrangement will help a tenant gain an ownership interest and allow the investor the means to purchase a property. 

As the market becomes more jittery, tenants will want to pay closer attention to lease terms and documents that pertain to the Subordination, Non-Disturbance and Attornment Agreement (SNDA). While the standard lease provides adequate protection,  many tenants do not obtain the important Non Disturbance Agreement from the Lender. Generally, the tenant agrees to subordinate their lease to the lender. In exchange, as long as the tenant fulfills their obligations, they won’t be evicted in case of foreclosure. In normal times, most lenders want the tenants to remain, but in uncertain times as is now is occurring on the residential side, many of customary procedures will no longer apply.  

Group Investing Returns 

Many of the wealthier property owners have sat out the past several years. Cash had no value and returns were unfavorable. Now that easy financing is gone, many of the cash investors will return once prices reach a level they consider acceptable. Some of investments will take the form of a group investment where partnerships are formed to raise capital. These syndications especially allied with a tenant will prove a promising area as loans become more restrictive. Forming a group will be one way to contribute the additional equity that will be required. Group investing will be a return to the past and should give developers more control than the investment bank partners they may have recently had.

 

INDUSTRIAL TENANTS

August 20th, 2007

Many owners wonder about the stability of their tenants. Of course, everyone wants excellent credit or a strong personal guarantee to secure the lease. However, stronger credit tenants will gravitate to newer and better located properties, while leaving a vast pool of older buildings in less desirable areas to sort out the lesser credits. This is not necessarily a new situation, but because today’s tenants may have different racial profiles, come from a foreign country, use English as a second language, and have new business models, this makes underwriting a new tenant more complicated and risky. Additional security deposit, guarantees from other associated operations, or personal background checks may help. However, owners are more likely to find there is simply not a lot of cash or personal net worth. Many will be good paying tenants but they either come from fairly humble backgrounds or are putting all their resources back into the business. This condition mirrors the world economy with the rise of many powerhouse companies from India, China, Mexico, and Russia.

Here’s an example of a typical tenant today. It starts out with a driver and a couple of trucks. If they get lucky they find an account or two who will pay for some warehouse space. When the company moves into a new building, they hire labor by word-of-mouth or from a street corner. New drivers are independents with their own trucks or are novice drivers from the same hometown. By sheer guile and margin shaving, the company begins to undercut the national truckers. The new customers don’t ask a lot of questions and are unaware that the considerable savings come from older, smog-creating trucks, labor practices that may not fully meet state and federal requirements, and a warehouse that is in violation of several fire department and building codes. Nevertheless, the trucking company moves into a new 100,000 square foot warehouse owned by a major landlord and they continue to expand with several more major accounts. This is an example of the American Dream that repeats itself in the garment, metals, and construction industries. Unfortunately, companies like these, and there are many of them, do not meet the test of careful financial review.

Landlords will judge from the pool of tenants that are in the market at the time their building is vacant. Without sterling credentials, landlords may need to decide on factors that can’t be substantiated on paper. Personal impressions, business plans, appropriateness of the use, and other subjective factors can be helpful when documentation and monetary resources are lacking. Every building owner wants credit, but businesses that evolve from the core of the metropolitan area or from places around the world will need to be examined with different standards that reflect outsourcing, sub-contracting, and diverse business models.

Property Search and Community

 

For those who follow technology and real estate, Search is essential to success. Search is Google’s primary business and is how real estate buyers spend their day. When one carefully defines the relationship of search terms, the better the results. Likewise, when one defines the search parameters for property, the better the deals. Before the Internet, Real Estate Search was conducted by word-of mouth the Multiple Listing Service, and massive cold-calling. It was not easy to be specific. Today, new technologies allow pinpoint accuracy. CRM software, owner and tenant databases, search engines, aerial maps, mobile wireless internet cards and GPS enable one to segment the market into various product types. With massive amounts of capital looking to gain an advantage in different expertise areas, these new search tools have allowed Buyers to look more exactly than ever before.

Simply consider how Google Maps has changed Real Estate. I also like News Feeds because they can automatically track all types of current and specific information. Besides Search there are prototypical ways to conduct business. This next stage is typified by Social Networking sites such as MySpace and Facebook. While not business ready, these sites are based on creating community and relationships. A community, for example, can create an entire ecosystem of capital, lenders, tenants, and property in areas that are otherwise disorganized. Searching for like-minded people and telling others what you do is the basis for Social Networking. While none of these concepts are new to the business world, Search and Community sites will take you further, deeper, and faster. There are other parallels between how deals are sought logically and how their future will be enhanced digitally. Perhaps it can be seen by what is happening today. Search is being used to ferret out the bargains. For instance, any real estate occupied by companies associated to housing such as material suppliers, furniture makers, lenders, residential contractors or Home Depot vendors is being carefully examined for failing tenants. Other Searchers will look at property or companies who are caught in changing capital markets and will need new financing. The community of Buyers is also changing from those who relied on borrowed funds, to those that have cash and Community are excellent tools for Real Estate Professionals, and they enhance our ability in the most important way—finding and making deals.