Commercial Investment Valuations are typically presented as cap rate driven: the lower the cap rate, the higher the price. Investors have the challenge of balancing asset security and safety vs. an acceptable Cap Rate return.
Security and safety include a matrix of attributes: Extended Lease Term, Quality Tenant with good credit history (and track record of business acumen), LOCATION (both the immediate demographics and street/area positioning), a favorable NNN lease, long term appreciation aspects, and financing desirability. However; how low can you go? Cap rates in desirable urban settings wafting in under 4% need a compelling story to convince me.
REMEMBER the OLD Adage: “It’s not what you make; it’s how much you keep.”
Evaluating your cash on cash return is as important, if not more important than a cap rate. If your investment is predicated on a 4% cap rate but the cost of the funds is above that, you are going backwards. It can make sense if you are going into a Value-Added Property, or compelling project that offers an opportunity to increase the income to the current market conditions. No one size fits all but sometimes “all that glitters isn’t gold.”
When looking to understand a property’s allowable land uses and zoning we look to the City or County zoning code and zoning map. These give us an idea of what uses are currently permitted at a property, which uses are not permitted, and which uses require a minor or conditional use permit. It provides a snapshot of the current state of the property, but it doesn’t give any insight to the future of the property. This is where the “general plan” comes in to help give the public an idea of the direction of a specific property or neighborhood. The general plan will have both maps and text available to help show what the goals are for an area and it serves as a blueprint for location, type, density, quality, and rate of development. Having knowledge of the future development of a community is very important for real estate professionals so that we can advise our clients in their real estate activity. Understanding the goals and needs of specific areas including infrastructure, demographics, resources, and overall economic growth can help determine if a property is suitable for a client’s needs. Determining the highest and best use of a property must take into consideration the current zoning as well as the general plan.
A GASp at CASp
Oh where, oh where, do we begin in attempting to evaluate the recent California ADA Access requirements that may have created one of the most murky and predatory law environments for commercial property owners’ in California today?
Before I begin, let me state that the quest to create access to the disabled sector of our communities is noble and needs to be supported. This article in no way is intended to imply that no efforts need to be made to eliminate access barriers in the marketplace.
But in the spirit of the “Law of Unintended Consequences”, the current ADA Compliance requirements that have been identified in the “New CASp Legislation” will have you scratching your head in utter amazement at the lack of foresight.
ADA Requirements came into law in 1991 and those requirements have been updated in both 2010 and in 2013. In efforts to be fair to existing property owners, language was added to the new regulations that attempted to call for reasonability that said, ” Readily Achievable to do so”, and further providing a “Safe Harbor Provision” to property owners who’s improvements were already completed prior to the approval of the new legislation. Compliance issues have been further complicated by the fact that ADA REQUIREMENTS are a Federal Mandate; although the actual enforcement of the Rules have been historically relegated to the local municipalities,thus creating a vast area for yet more ambiguity.
But Wait!! That’s not all! There’s more.
Further complications have developed by a California Supreme Court decision opining that any non-compliance with ADA STANDARDS IS AUTOMATICALLY a violation of California disabled access laws. You don’t have to show proof of damages, and now California leads the nation in the number of access lawsuits. The fertile ground for predatory frivolous lawsuits was born.
Enter the new CASp survey. This program was developed as a hedge to protect property owners against the slew of vicious lawsuits littering our judicious system, but it too appears to have backfired.
The “Updated” Requirements suggested in the CASp inspections can be expensive to implement because, (of course), most buildings have been constructed under the previous approved standards, thus creating yet another quagmire for commercial property owners.
For instance, in making a determination as to the updated requirements for CASp Compliance, has the owner been put on constructive notice that existing improvements MUST be modified? THAT IS A RHETORICAL QUESTION. What if the changes between the approved Compliance Regulations from 2010 to 2013 to the New CASp Requirements that amount to like an existing improvement now being 2 inches off, or a ramp slope that needs to be repaved (even though it passed inspections in the past and was certified) because the slope requirement has been modified? Is that reasonable?
I honestly don’t know where the lunacy ends, but one thing to consider if you are planning a CASp survey is to have your attorney order it for you, thus citing attorney /client privilege. You may want to Google ADA Defense Law, and read what their opinions are regarding protecting yourself as property owners from this legislation (run amok) phenomena that is leaking into our investment environment here in California and creating havoc for Commercial Property Owners.
It’s amazing that we are facing the end of 2014, and I was shocked to hear that Christmas is about 14 weeks away and away we go with putting away the end of the year.
If you’re considering some end of the year tax planning and/or liquidating some real estate assets; you may want to re-acquaint yourself with the “ends and outs” of doing a 1031 Exchange and make sure you are ahead of the process even before you get started.
A 1031 Exchange may be even more desirable this year than in years gone by because the Capital Gains threshold was raised by both the Feds and the State at the beginning of 2014. The 15% Feds rate went to 20% and the State raised their rate from 9.3% to a little over 12%( with more tax collection formulas that impact people in various tax brackets that won’t be discussed here), but I want to illustrate that everyone will be exposed to Real Estate Capital Gains tax UNLESS they do a 1031 Tax Deferred Exchange at the time of sale. When selling buildings that have been depreciated; there’s a 25% tax recapture formula of the depreciation of this asset unless you do an Exchange.
For Estate Planning Purposes; a 1031 Exchange gives you the option to delay Capital Gains exposure indefinitely with the anticipation that your accrued capital gains tax will be ultimately “wiped out” when you die and the property ownership is passed on to the survivors. The properties can then be reassessed and the new market rate valuations will replace the old basis. All appreciation will be rolled into that new evaluation. An exchange is also a vehicle to preserve and grow your real estate equity because you can exchange indefinity.It gives you the opportunity to keep the Financial Horsepower working to build your estate and completely avoid paying taxes.
The rules for compliance to complete an exchange are actually reasonably simple, but the actual execution of the sale and purchase has a few “mine-fields” you need to be aware of to protect the integrity of your transaction. You want to stay in compliance with the rules the IRS sets forth. The last thing you want is a failed Exchange.
In a nutshell; the IRS gives you 45 days from the time you close escrow on the property you own to identity property/ properties you may want to own. These properties need to be at the same (or greater) price of what you’re selling and you need to replace any existing debt you have on your relinquished asset. New properties can be anything of a
commercial nature but cannot be your primary residence. (There is a 5 year Strategy to convert income property to a primary residence that won’t be discussed here)
You can nominate 3 properties you wish to purchase or you can nominate any number of properties as long as the combined aggregate value of all the properties does not exceed 200% of the value of what is being sold.
You select a certified accommodater, or a trusted attorney to accept a written list on or before your 45th day from the sale of the relinquished property and you then have 135 Days to complete the purchases/purchase. You have 180 days from the sale of your relinquished property.
Simple enough, but the “Devil is in the Details”.
Here are some things to be concerned about and problems that can be avoided by developing a flexible strategic framework before you even begin.
Remember to check your vesting to determine the actual ownership. If the property is held by a group or individuals who all want to exchange; you have no problem. However, if the property is owned by partnerships/LLCs, (etc.) that want to go in separate directions; the vesting needs to be updated prior to
the sale. (Tenants in Common are an acceptable way for multiple parties to hold Title and move in separate directions).
The IRS requires the same ownership entities to be involved in both the sale and the ultimate purchase.
Even if you are a seasoned Real Estate Investor; identifying a suitable property in a short time frame is a compelling task. It can takes weeks of negotiating into a contract and completing a comprehensive due diligence study can take awhile. The last thing you want is to discover 5 days before the expiration of your intentification period is that the perfect property has a dastardly problem.
Be aware that you can buy LEASE-HOLD Improvements, but the underlying ground lease must have a minimum of 30 years left on it, and you want to make sure that ground lease includes Options to Extend.
NNN Leased Investments can be a reasonable alternative for your Exchange because typically they have been “groomed” to sell quickly and have a well-prepared due diligence package assembled with all the inspections and leases in order.
Even then; you need a site visit and you may need to conduct more inspections if the Sellers Information is not comprehensive.
The sooner you begin to explore the markets/investment type you may be interested in owning; the better off you are. Learning and educating yourself about the opportunities available to replace your existing asset is critical to preparing yourself to understanding values.
Also; try to insert a provision in the initial Purchase and Sale contract that allows you (at your) option to extend the Close of your underlying Escrow for 30 days if need be to create a little wiggle room.
Begin to look for investments the minute you go into contract, and don’t be afraid to write offers. You can be so ahead of this process that you don’t even need forty five days because you will be ready to purchase your new asset immediately after you close your primary escrow.
An ounce of prevention is worth a pound of cure. The investment market remains strong and the Interest rate climate remains low making this an even better time to re-position your equities for a better return. Happy Hunting
Senior Real Estate Advisor
During the so-called Great Recession there were a lot of strategic moves within the North Bay market. EOP let go of their huge holdings at the beginning and then we were all surprised when RNM sold their holdings to PB&J and Investcorp. Basin Street picked up most of the EOP properties and PB&J started aggressively marketing their properties. All kinds of broker incentives floated around, but the deals are not driven by the brokers. They are driven by the market, which is to say they are driven by psychology and emotion. Sit down and analyze spread sheets. Project cash flow scenarios. Make it a good deal on paper. But I’ve had more deals over the course of my career die because a principal doesn’t “feel” the deal is right than those which didn’t consummate due to logistics. It can be a no-brainer on paper, but it has to feel right in order to make it happen.
A case in point is a recent transaction I completed for a close to ten million dollar property. This is a property I’ve spent over twenty years working on. I listed the asset in March of 2013 for sale. Two days before the end of the year (and my sale listing) we signed a Letter of Intent with a purchaser. The purchaser and the seller had done a deal some fifteen years earlier, so they were known quantities to each other. I had presented previous LOI’s which were flat out rejected, yet this one stuck. The only reason it stuck, and this is a quote from the seller, was that “(He felt) good about the Buyer”. The deal had all the ups and downs of any large dollar transaction. Voices were raised. Promises were made. Back and forth it went. The problems were static, but emotions ran high. Economic trends were both valued and cursed in the same conversation. A broker cannot get involved in these emotional areas. Our job is to make it happen as directed by our client and to keep away from the murky waters of emotional highs and lows. We advise on the deal. We pay attention to the paper trail. We report our marketing efforts to our clients. We play Pocahontas when these emotions run high.
At the end of the day, the old cycles hold true. People start feeling better about the economy. People start feeling more secure about their endeavors. And properties start to lease and sell. Sometimes it is a slow process, but the curve can still be sharp.
As we round the corner midway through the first quarter of 2014 I find myself going from busy to busier. Everything from 200 SF office leases up to negotiation on 8-digit acquisitions is heating up. This brings about a new problem, or at least one I haven’t faced in quite a while: Inventory. Or a lack of it. Our retail specialist in the Petaluma office is having trouble finding space. I’m shoe-horning long dormant office spaces. Behind-the-closed-door deals are being struck. Inventory is dwindling. While office still has a long way to go, I’m going to focus my energy on picking up more office inventory. Why? Again, because the curve can be sharp. I’m also focusing energy on picking up industrial inventory, as that sector is almost non-existent in Petaluma and the surrounding areas.
Here we go (again)…
Happy New Year to all, and I trust that 2013 contained a “Healthy Dose” of Upside to most of Northern California Economy. Certainly the Residential Market continued its climb with consistent momentum, and we witnessed the biggest shift in residential development land sales in over 5 years; all bellwether signs of a new economic dawn. It’s safe to say the Tide has turned and we look forward to similar economic momentum in the new year of 2014.
As the Saying goes “Follow the Money”, but I would modify it to say “Follow the Interest Rates”
According to Brian Kilkenny at Exchange Bank; the general consensus in the banking world appears to be the economy is getting stronger, but the growth is not overwhelming.Hence; interest rate may not be rising as fast as they could, but we can expect a gradual rise in rates throughout 2014.
We can anticipate the days of 4% money may be a thing of the past by mid-year, and the 10 year loans (close to a dinosaur today) will also be a thing of the past as Banking Regulators continue to ratchet up loan criteria and guarantee fees.
So; what’s the conclusion? As my dear old mother used to say “Make Hay while the Sun Shines”. Today’s interest rate environment will not last at the levels we are experiencing, and now is a great time to make a move to purchase both investment property and take advantage of both income property and property suitable for Owner/Operators eligible for SBA Loans. “Time Waits for No Man” (or Woman for that matter)
Contact us today if you are considering taking advantage of today’s advantageous interest rate environment.We look forward to hearing from you.
Annette Cooper, Senior Real Estate Advisor
Leasing activity continues to be exponential when compared to the sales volume we are witnessing in today’s market. Consider that leasing activity has outpaced sales volume approximately 20 to 1 within the past year. This phenomenon is particularly of interest considering the historically low interest rates available to (who appear to be) qualified SBA Borrowers, but perhaps it’s a reflection on the stringent terms and conditions that have been imposed upon these potential buyers by banks and regulators to qualify for new loans. After reviewing sales over the past 12 months for office and retail properties, it appears prices are trading in the $190 to $210 per square ft. range. Further downward price pressure has been exerted by the REO nature of several of the past sales, and compounded by any motivated seller’s necessity to compete with these comps in order to get a property sold. 775 Farmers Lane is one exception which sold for a whopping $255/sft. That particular building needed a complete interior overhaul, but the large lot and its superior retail presence (across from Montgomery Village, on a major traffic artery) made that an unusually well positioned attractive opportunity.
In looking into my crystal ball, I have to believe that this current trend of sales to leasing will slowly begin to even out in 2013. This trend will be predicated on a couple of things. One is the encouraging note of the softening lending environment. Commercial Lenders are beginning to take a broader, more global approach to the Approval Process, thus opening buying opportunities. Additionally, with property prices hitting historic lows and the accompanying interest rates following suit, the market opportunities are hitting a kind of critical mass. Finally, after years of eroding marketplace confidence, a burgeoning Bay Area Economy is beginning to fuel a perception of renewal and economic growth. Buying in a rising tide of economic growth may be winning strategy for a new crop of strategic investors…
Cities that are flexible with parking ordinances are attractive to business and jobs. For instance, the City of Santa Rosa’s parking requirements are as follow:
Office: 4 parking spaces per 1,000 square feet
Medical Office: 3.3/1000 for clinic, lab or urgent care and 5/1000 for doctors’ office.
These requirements are for on site parking. Many times a vacant under-parked building may have a hard time securing a tenant with these formal restrictions. The purpose of this blog entry is to inform you about the City of Santa Rosa’s “Aggressive Economic Development” ordinance. Section 20-15-030(B) has the parking regulations for change of use:
B. Existing buildings shall be allowed to change use (for example a retail use to a restaurant) without meeting current or newly adopted parking requirements for the building site, excepting compliance with ADA standards, provided the parking deficiency is no more than 10 spaces or a 25 percent overall reduction from standard requirements, whichever is greater.
This ordinance shows that the City is taking a step in the right direction in regards to turning on lights in vacant buildings. I believe that it is more productive to work “with” the City to help provide solutions than it is to work “against” the City and just complain about the problems.
The last quarter U.S. GNP has been revised upwards to 2.8%, not great but better than the 2% GNP growth rates of the previous two quarters. Are we pulling out or falling back? We still have not had the kick up in employment which signals that new job growth has brought in new entrants to the market. However, the Palo Alto-Santa Clara job market has reported one of the best in the country and South of Market is exploding with new major leases with leasing rates rising 46% in one year.
While the national investment market for office buildings at the institutional level increased by 37% last year, the private capital investment has not rebounded the same. What we have is a bifurcated market, one for institutional investments and one for private capital.
So what is our forecast for commercial leasing and sales for the North Bay in 2012? I’d say more of the same spotty market conditions. We have had new corporate start-ups in 2011 so leasing of “A” space has been good but the real economic bellwether-leasing of “B” space is just beginning.
Local commercial lenders are back in the market with loans in the 5% and 6% interest rate region with increasing leasing and bottom of the trough pricing, real estate investments are a good choice today.
Compared to the paltry returns for fixed and debt instruments and the risks of the stock market, commercial real estate is the best investment choice for many.
While companies and owners looking for a long term home for their business snapped up the bargains available through institutional and lender wholesales of property, investors are only beginning to take advantage of leased up buildings and the lowest loan constants in 40 years.
We also believe that the Main street businesses will gradually come back, tired of waiting on the sidelines to see what’s happening to the economy and will increasingly expand, consolidate, move and add new locations.
While some economists are predicting that the next quarter is at risk of not rising at 2.8% GNP growth, others see positive signs on the horizon.
We feel the latter will happen in the North Bay. The favored industries that are projected for job growth are all located here: healthcare, tech, medical devices, telecom and alternative energy.
The expansion pressure of the South Bay tech companies and the exploding San Francisco social networking companies will continue to keep real estate values and growth in the North Bay on an upward slope.