25 Years of Doing One Thing and One Thing Only

May 15th, 2019 marked my 25th anniversary in commercial real estate. I remember that day in 1994 vividly, and my heartfelt enthusiasm remains a fond memory as I walked into the West Los Angeles office of Sperry Van Ness ready to sell investment real estate. I graduated from USC the week before with a Bachelor’s of Science degree in Business Administration with an emphasis in Entrepreneurship.

Why Commercial Real Estate?

I was always wanted to have my own business, be my own boss and determine my own fate.  However, I didn’t have the capital or the means to borrow money to start my own venture in addition to the surmounting student loan debt that often accompanies the “5-year plan.” I went on several, extensive on-campus interviews with many companies that offered attractive sign-on packages, including decent starting salaries, company cars, and sales training . I was drawn to the commercial real estate recruiters offering a path to success paved with the spirit of entrepreneurship.

Most startup companies strive to get between 10-20 % profit margins while commercial real estate companies offered 50% at their expense and training. It was a no-brainer! The fact that only about 10% of those who start in the business only make it to year three (where most start to make real money) didn’t scare me at all.

After all, I was different – not only was I a USC Business School graduate, I was a USC Business School Entrepreneur (I hope by now you understand I’m being tongue-in-cheek here). What I eventually learned is that the real world sometimes has a cruel way of opposing idealism with ambition!

As I recount my years in the business and celebrate both my successes and failures, I can offer four items of advice based on my experiences, to help anyone considering a career in commercial real estate:

1) Know your value proposition, your customer, and know that they will continually evolve.

The very first thing I learned in my early career was that REO was an acronym for “Real Estate Owned” and basically meant foreclosed property.  It seemed like every property on the market was an “REO” and the only agents that were successful were those that had relationships with lenders. I quickly learned that my value proposition was not to clients but to other agents that could use my computer skills; i.e Lotus 123 (before Excel), PowerPoint, and Word to help create proposals to lenders looking to sell their REO properties.  Days were spent sitting by the fax machine and waiting for response to offers and counter offers.  The use of e-mail was still years away.  

In 2008 I made a transition to Colliers International. Soon afterwards I was invited to participate in an overseas training program to Australia. I was the only American invited to a five-day training program with 50 other Colliers colleagues from Southeast Asia, New Zealand and Australia. Besides solid intermediate agent training, we spent five, ten-hour days learning about valuation, marketing strategies, handling objections, sales positioning. My most important take -away was that my value proposition should not be confined to a geographic area.  The international exposure taught me that challenges and opportunities know no boundaries.  

Eventually my value proposition evolved again, and I created a “unique ability” based team that can managed every element of a transaction from underwriting, positioning, marketing material creation, distribution and transaction management.

2) You cannot do it alone. Find a complimentary partner(s) and become one.

Eight months into my tenure at Sperry Van Ness all the agents were summoned to a meeting where we were told that we were no longer affiliated with Sperry Van Ness. From that moment forward we were to be known as “real estate offices.”  What that really meant was we were let go because of a conflict between the franchisee and franchisor. 

That same day I walked across the street to the Grubb & Ellis office and asked to speak to the office manager. I explained my situation, and he took a chance on me.  I would spend the next thirteen years at Grubb & Ellis rising from Associate to Senior VP where I sharpened my shopping center knowledge by affiliating myself with retail leasing teams. I spent every single weekend driving trade areas and learning about all of the different grocery anchored shopping centers in Southern California. 

I began helping agents with their pitches and leasing agents sell the properties they were leasing. By May of 1997 (three years after I had started my career) I sold Centerwood Plaza, my very first grocery anchored shopping center that I had sourced, proposed, listed and closed.

In 1998, I was invited to participate in a presentation to dispose of nearly one billion dollars worth of real estate from Mitsui Fudasan America. Grubb & Ellis won the assignment and the agents with most seniority sold the best properties in the portfolio. For next two and half years I sold some of the least desirable real estate for the negotiated commission rate of one percent. Nonetheless, the collaborative experience was invaluable.

3) Have a business plan and don’t be afraid to pivot.

When I began my career in commercial real estate the US economy was in a major recession and Southern California just got hit with massive aerospace layoffs. Los Angeles was still recovering from the major Northridge Earthquake and the scars from the 1992 civil disturbance had yet to heal during the long OJ Simpson trial. I did not know how to conceptualize it at the time, but I now know that my resourcefulness and ability to pivot my value proposition and business plan were key to my survival.

The shopping center industry is going through another disruption and I am now surrounded by the most experienced partners I have ever had and the best support infrastructure I have ever experienced. I will continue to carry a willingness to evolve and I look forward to growing within a strong brokerage and capital markets platform.

4) Find that ONE thing and stick to it.

During my college years in June 1991, my girlfriend took me out on my birthday to see a movie called City Slickers starring Billy Crystal. If you are unfamiliar with the movie, it is about three middle aged men from New York City that go on a two-week supervised cattle drive through the Southwest. As the three men reflect on their lives on horseback, the fear of aging and unfulfillment resonates in their discovery.  In a later scene Mitch, played by Crystal, strikes a bond with the trail boss, Curly, played by Jack Palance. Palance is a rough, leather skinned cowboy that has lived life on his terms and rules.  

Mitch, says to him, “you know that’s great, your life makes sense to you.”

Curly looks at him and says, “you city folk worry about a lot of sh*t… you spend  50 weeks a year getting knots in your rope and you think you can come out here for two weeks and untie them…do you know what the secret to life is?”  As he raises his index finger, he says “One!”

“ One what?”  Mitch asks.

“One thing. Stick to that, the rest don’t mean sh*t”, Curly responds.

I accepted my offer with Sperry Van Ness in 1994 because of their young culture and their singular focus on investment real estate sales. And, they had computers! The training was very thorough and new agents were encouraged to choose a specialty – the ONE thing. Since about 90% of the agents were working on multi-family, I decided to go with retail.  Shopping Centers were to be the one thing I would focus on.

Sticking to only selling shopping centers has helped me transact across the country.  In 2010 I sold my first shopping center in Hawaii, in 2012 I sold a shopping center in Mt. Olive, New Jersey and by 2016 about half of my brokered transactions were outside of Southern California.

Rewinding to now.

I have often been asked during the past 25 years: when are you going to become an investor? When will you “jump the fence” and start buying shopping centers?

My simple answer is:  I really enjoy what I do. After a successful sales campaign and the property sells, I get to go to the next challenge.

I am now settling in at JLL and after spending 10 years (to the day) at Colliers International. As I look ahead to my next 25 years, I plan on doing one thing and one thing only : selling shopping centers.

To Price or Not to Price?

One of the biggest challenges for brokers and sellers of commercial properties is deciding whether to price or not to price a deal. There are various factors to consider; How big or small is the property? Is it a core, trophy asset? What is the property’s marketing strategy? What kind of timeline is the seller expecting? Is there a need for a quick sale or is exposure more important? Should a property go to market unpriced and then have a plan for pricing later down the line? There is no right or wrong answer to this looming idea; however, there are advantages and disadvantages to both.

Priced Deals

Target is set for buyers.

With a price given clear as day on an OM or marketing brochure, there is no ambiguity about where the price should be for buyers. This gives a sort of baseline for underwriting and a starting point to discuss the potential of purchasing a property. Returns, both leveraged and unleveraged, can be easily computed. However, this could alienate certain buyers. If an investor feels as though a property is out of their price range, they may not even look at or submit an offer on the property.

Pricing a deal also allows for a targeted buyer pool to know immediately whether it is in their range and can helpful with 1031 requirements.

More clicks.

Priced deals generally get picked up in more searches than unpriced deals. More clicks equals = more views, generating and more excitement for a deal can be generated through online marketing. More clicks and views does not mean more offers or a higher price, though. Marketing must be targeted towards certain buyers and groups to get the “right” kind of attention. Read more about our targeted marketing strategy here.

Less Competition.

For first time buyers or investors that don’t like to feel pressured into purchasing a property, priced deals are a better play. These buyers typically do not want to enter into a competitive bid situation. Unpriced deals may drum up unwanted pressure to outbid other groups. It is important to note that Less competition may not attract the right offer or buyer, and the opportunity to get a higher price may be missed.

UNPRICED DEALS

Appeals to institutional investors.

Unpriced deals are mainly geared towards larger, institutional clients that are looking for that special investment. These deals are usually $50 million+, attracting larger clients that are skilled in evaluating purchasing unpriced deals. However, even institutional Cclients may want or need guidance through pricing on a deal. And, an unpriced deal could fly under it could miss the “radar” when buyers are looking at deals in a certain price range. It can either not show up on a site or could get overlooked completely.

More interaction between buyers and brokers.

With Tthe mystery of leaving deals unpriced may  createcome more questions, comments, and interaction with potential buyers. This is great for building relationships and demonstrating your knowledge of a property or market. A broker cannot give specific returns. A range of returns could be discussed, but this implies a valuation, which can be incredibly limiting.

More competition.

While I mentioned above that less competition is an advantage for priced deals, in this case, more competition can be very positive. Unpriced deals leave more room for multiple bids which can in turn create a higher sales price. This isn’t right for every buyer – creating the perception of a competitive bidding situation could deter certain investors. This could also lead to lowball offers from buyers who are trying to protect their lower-end valuation.

A few final thoughts.

As mentioned before, there is no clear answer for whether to price or not to price a deal. However, for $50 million+ deals, it is generally suggested to market a property on a unpriced / best offer basis. Select circumstances, such as a redevelopment site, true trophy assets, and unique properties such as food halls may warrant unpriced deals as well. Otherwise, sellers are better off pricing their assets. For a longer marketing timeline where exposure is the most important objective, unpriced may be the way to go. More interaction with potential buyers helps to give not only the property lots of exposure, but also the brokers. Interactive and interesting marketing materials may be needed and this could take quite a bit of time. For a quicker sale that may require less interaction between brokers and buyers, priced is best.

Los Angeles Rising: Trending Neighborhoods and Rising Value

Los Angeles is an ever-changing landscape – ever growing, ever developing and ever expanding. As new streams of residents enter the dense urban landscape, developers are continually building to meet the increasing demand for accessible housing. As cranes dance around Downtown Los Angeles’ skyline, developments continue to pop up in trending hot-spots like Echo Park, Highland Park, and Silver Lake.

Echo Park, Highland Park, and Silver Lake have grown exponentially over the past decade and these so-called “hipster” neighborhoods have become epicenters for gentrification. Although these areas have gone through various stages, history has shown that they have always attracted hip and urban influencers through the allure of untapped potential, ease of accessibility, and a relatively lower cost of living.

These neighborhoods also hold a significance to a larger Los Angeles narrative.

Rooted in Los Angeles’ Cultural DNA

Silver Lake became a refuge for the LGBTQ community in the late sixties, notably shown through the peaceful demonstration in February of 1967 held at the Black Cat Bar. Now a historical monument, the Black Cat Bar was the site for the first documented LGBTQ civil rights demonstration in the nation. Over the past 10 years, Silver Lake has developed into one of the most expensive areas in Los Angeles’ East Side, boasting affluent residents and hip and trendy retail and restaurants.

Highland Park Bowl was erected during the midst of the Prohibition era for a place to relax and have fun. Over time, the facade was covered and the building became a local hangout for punk-rockers to see live shows while being rebranded as Mr. T’s Bowl. In 2016, a local group purchased Highland Park Bowl and through a demolition discovered that much of the original venue could be restored and repurposed, continuing a common thread that ties many of the redevelopments throughout Los Angeles’ East Side.  Highland Park  is still going through an expansion and developers are discovering the demand for more housing. Luxury condominium projects and new tenants are just starting to sprout along the streets of this historic community.

Echo Park, nestled in between Highland Park and Silver Lake, represents the middle ground of the gentrification battle. Currently, rent in the area is approaching astronomical levels while the seeds of initial developments are reaching fruition and many are asking if they are already late to the proverbial party. There is still a strong mix of both new and old in Echo Park, and reverberations remain of cultural and counter-culture movements that began along Glendale Boulevard and Echo Park Boulevard.

The Rising Tides of Value

There is a strong correlation between development, gentrification and rising value. The median value of a home in Highland Park in 2013 was $426,000. In 2018, the median home value was $801,400, which is nearly double that of 2013, and an increase of 11.6% from last year, and is anticipated to increase 6% next year. In Silver Lake, the 2013 median value was $658,000, and in 2018, $1,184,000. [Again, nearly double in value from 2013, and a healthy] increase of 13.4% from last year, with an expected rise of 9.4% next year. Echo Park tells a similar story; the median value of a home in 2013 was $475,000, and in 2018, it rose to $850,900. The 2018 value is an increase of 4.81% from last year and is expected to increase by 5.6% next year.

All three neighborhoods have median home values that grew by nearly 200% in just 5 years. The rent prices for a 2-bedroom, 1-bathroom apartment tell a similar story

Median Rent Prices 2012 2018 Increase
Echo Park $2,347 $3,700 150%+
Silver Lake $2,195 $4,300 190%+
Highland Park $1,100 $3,495 300%+

As the residential market started to boom, so did the retail market. Along the main boulevards in these neighborhoods, retail rents are continuing to increase year by year. Along Sunset Boulevard in Echo Park, the triple net asking rent per square foot median price in 2012 was $24. In 2018, just 6 years later, the price rose to $31. Glendale Boulevard exhibited the same price fluctuation. On Sunset in Silver Lake, the median price rose from $28 to $41 over the same period of time. Figueroa, Rowena, and York all saw similar price hikes and all are expected to grow exponentially in the years to follow.

The Hipster Aesthetic

The so-called “aesthetic” culture of these areas is part of what is making them thrive. Around every turn, there is always an Instagram worthy moment at a cute coffee shop or hip boutique. Millennials love to enjoy a $5 cup of coffee that they can snap a pic of and share with friends.

Our team recently marketed a newly redeveloped building in the heart of Echo Park, providing a prime example of this new aesthetic.  Much of the appeal of Mohawk Collective comes from its design – all glass, iron elements, and exposed industrial vibe. Many developments and shops in this area are a part of this style and they attract consumers. The area directly around and in Echo Park, in general, will inevitably follow in this design retail trend.

Notable Developments


Other new developments in the area, like 1111 Sunset, are continuing to attract visitors and residents. This project will include 994,000 square feet of residential, commercial and hotel space with 778 condos, a 98-room hotel, and a 4000 square foot conference center. Other high-end residential developments are popping up, like The Griffith in Silver Lake and Alexan South Echo in Echo Park. The Griffith includes 11 3-bedroom single-family homes, starting at a price of $1,200,000. The Alexan will house 200 apartments, with rent prices between $1700 and $3900 per month.

These developments will attract new residents and visitors, driving up both home values and retail rent prices. Various neighborhoods in Los Angeles are following this same trend. Keep a look out for our next post that explores which neighborhoods are quickly developing to join the ranks of Echo Park, Silverlake, and Highland Park.

Real Estate 101: How To Be A Better Buyer

It’s tough for buyers to be fully aware of what they’re entering into when investing in real estate. Whether it be a shortage of marketing materials, a lack of knowledge on all the factors of a building, or an underwriter leaving out a lease clause, buyers should be prepared to face a number of challenges.

Buyers may think that it is only the broker who needs to have a plan to sell; think again. It is necessary as a buyer to formulate a strategy considering that different properties may require different plans.

As a buyer, it’s not surprising if the following questions are entering your mind (and staying there):

-Where is the market headed?

-Am I buying at the right time?

-What is my investment goal?

-Do I have (or need to have) a plan B?

Tips to Follow as a Real Estate Buyer

1) Know your strategy.

Be firm on your position and know your parameters. Some brokers may try to push a buyer into a deal. While not all pushing is bad, a buyer must be ready for this. If a deal ends up moving outside of these set parameters, make sure you understand the implications of going outside of these parameter before moving ahead. Know what is absolutely important to you, and stick to your guns.

2) Do your homework.

Make sure to dig in quickly. Ask lots of questions. It is a good idea to include a list of initial underwriting questions. Do your due diligence and enter the market as prepared as possible. We have a number of checklists available if you’d like one. Please contact us for more information.

3) Disagree without being disagreeable.

For a brokered deal, always remember that the broker’s job is to market and promote a property. I’ve found it beneficial to have the initial conversation be open and appreciative. I strive to be pleasant and appreciative, regardless of the other side’s demeanor or response. This helps you to keep a positive outlook and makes conversations with brokers go much more smoothly.

The same applies to conversations with the owner. Go in with a win-win mindset, rather than adversarial. There are cases where some people respond better to a challenge, but most human nature is such that confrontation begets defensiveness and hiding; don’t give someone a reason not to talk to you. Referencing the tried and true maxim: “it is easier to catch a fly with honey than with vinegar,” kindness and genuine respect can take you very far. You might even make a few new friends and learn something unexpected in the process as well!

Be thoughtful with questions and comments; this will promote respect from both parties. Tone and attitude are very important to creating a positive transactional environment, and this comes from developing an understanding of both the market and the broker.

As a buyer, you are the main driver of the real estate market — remember this! You hold power in your hands. Take advantage of this, but remember the suggestions outlined above. Investing in real estate is a two-way street, requiring cooperation and communication from both sides. We published an article earlier this year outlining effective forms of communication during the acquisition cycle that illuminates this point more clearly. As a buyer, always remember to ask thoughtful questions, keep a positive tone and outlook, and have a strategy that you stick with. Remembering these tips will make you a formidable buyer.

Industry Changing Insights from ICSC RECon

ICSC’s 2018 RECon Global Retail Real Estate Convention hosted the world’s largest global gathering of retail real estate professionals, among whom industry acumen and insights were shared and discussed. We answered questions like “What is the future of malls and power centers?” “How will technology play a role in maintaining a competitive advantage for retail real estate companies?” and ” How are internet sales impacting retailers?” From our various meetings and conversations, here is how the industry is changing, and what you can expect to see in the future:

1. Contrarians looking for power center product are finding higher yields, but are having a difficult time assessing risk. How this shows up in the market is fewer offers made, and pricing significantly off of Sellers’ expectations. There still is a truing up process going on in this part of the market, and the balance of 2018 will reflect this shift.

2.There is high competition for grocery anchored product, with pricing remaining firm in this product type. This lack of softening on pricing reflects investor sentiment that there is less risk in this area of retail.

3. Daily needs shopping is not as threatened as was perceived last year – Internet sales are enhancing sales for daily needs retailers, and not threatening them. Most shoppers still want to pick certain grocery items personally. However, some items they are pre-ordering which they pick up after shopping for non-preordered items.

4.Malls continue to seek their equilibrium point in the market – pricing for this product type remains very soft, reflective of reduced demand, lack of financing, and a collective view is that there is much more fallout in this sector – some saying that there will be half as many malls in the future as there are today. The adjustment will take many forms, ranging from partial repurposing to alternative uses, to complete scrapes.

An interesting observation from one seasoned client: The demise of malls started with the rise of the two-income family, which led to shorter and fewer shopping trips, and a higher focus on value, which fostered the development of power centers and the advent of discount retailers.

5.Technology is a key to maintaining a competitive advantage. For some it will involve AI, and for others a more robust use of existing technology. Real estate in general has been slow to adopt technology, however retail tenants are definitely embracing technology as part of their operating strategy. Mobile phone data is being leveraged in many ways including tracking consumers, spending patterns, etc.

6. There remains a disconnect between buyers and sellers on pricing overall, but that gap is narrowing, and we anticipate a high volume of transactions in the third and fourth quarters of this year.

In general, we are in a transitional market with more optimism than pessimism. Retail investors need to carefully assess the risk of their portfolio and their new acquisitions. Fears about online retailing undermining sticks-and-bricks retail are overblown; however the industry is rapidly moving further toward value and convenience, tied to the changing lifestyle of the average American. Companies investing in technology maintain a competitive advantage. Let us know how we can help you.

Maximizing Communication Through the Marketing Process

Communication is one of the roots to successful project management, and the main difference between a project running smoothly or a project filled with missed deadlines and avoidable bottlenecks. One of the areas with a high probability for communication to affect process and productivity is in the creation of marketing collateral and marketing campaigns.

Process, Process, Process…

Miscommunication is deadly to productivity within the fast paced lifecycle of a marketing campaign. Many times, properties have strict client deadlines, and in many cases it is as soon as humanly possible. With speed-to-market being a top priority, it is imperative that a team operates on the same page from the beginning of the marketing process.

Project managers, graphic designers, analysts, brokers, and additional administrative assistants all help funnel along a marketing campaign from its inception to its launch. Having a battle-tested process is one of the most reliable ways to ease a communication dilemma. Our team has various processes for various product types, most of them beginning with a project kick-off call or meeting. This not only helps the brokers iron out any property positioning quandaries, it helps the team understand the project vision and their individual roles within the collateral building process while creating accountability.

A process is only as strong as its level of adherence, and this is where accountability becomes king.

Establishing Defined Roles for Greater Accountability

As mentioned above, defined roles create accountability. When analyzing the effectiveness of process—how to build, improve, and even celebrate—roles are critical to seeing where communication strengths and weaknesses lie. Defined roles also pair nicely with process because it promotes a symbiotic system of checks and balances.

When our team creates an Offering Memorandum for a property, we have various stages of quality control. Ultimately, there is one person who has the final check and stamps approved to launch. If someone misses an edit, the next person can catch it and so forth.

We can also invoke the imagery or reference of a McDonald’s assembly line. Each person has their defined role and strength in completing a certain task along this assembly line. When a team process is created, you put your team members with unique abilities in a position to complete certain tasks within that role. It sounds like common sense, but many teams rely on the wrong person to complete certain tasks. You wouldn’t go to a dentist for a haircut, would you?

How to Communicate with Different Productivity Styles

There are various ways to effectively communicate, though since every team is different, no exact formula exists. Our team utilizes various tools to understand how to effectively communicate with each other, including defining our productivity styles as illustrated in Travis Carson’s Market Force chart below:

All personality types cannot be completely defined to fit in these four categories, but it can provide a few tools and can help cultivate clearer channels of communication and understanding.

It is also helpful to see communication as a two way street. People are not mind-readers, and most often do not think the same way as you. After years of working with someone, you can learn subtle nuances and come to intuitively understand your teammates; but that cannot replace clearly communicating thoughts, ideas or instructions.

Make sure everyone is on the same page early on in the process, and those few extra minutes it might take you to explain your vision will undoubtedly make a difference in the end result.

Market Trends and Volatility on Real Estate Values

Assessing market cycles and risk is a necessary component of any investment strategy. Whether in a positive or negative cycle, there are opportunities in real estate beyond the “buy low; sell high” saying, depending upon long-term goals. However, it is much easier to assess previous trends. It is difficult to predict the future; otherwise, everyone would have predicted the market crash of 2008. To measure performance, we should look at how real estate compares to historical and emerging data, as well as other securities to mitigate risk.

Historical Data

Historical data includes sales information, vacancy rates, and interest rates. Sales data is widely used by the appraisal methods as it gives an indication of where property values have been. The downside is that sales comparables are often lagging and may not keep up with immediate corrections in the marketplace. Vacancy rates can tell us whether there is an surplus of spaces.

A great example is provided by Harvard Market Cycle Quadrants using vacancy and construction to show phases of the market cycle. If an increase in vacancy in a specific market is starting to occur, we may consider this phase to be an indication of an impending downward trend. Often new construction falls behind market phases. Once the market is in an expansion phase, companies look to new construction to capitalize on investment momentum. However, construction often takes time including design, permits and production. By the time the new product hits the market, there could already be a change in the cycle or even cause a change by increasing available units.

 

Another trend to look at is interest rates. When the Federal Open Market Committee raises rates, it affects the housing economy as well as investment properties. Generally as interest rates rise, a negative impact on residential properties will occur. Monthly payments increase and thereby affect affordability. As expected appreciation decreases, the desire to own may also decrease. And of course, interest rates affect investment yields. As the cost of borrowing increases, expected rates of returns must also increase. Recently, we have seen interest rates already increase with anticipated additional rate hikes throughout the year.

Securities

The risk of investing in real estate also must also be compared with returns on other security investments such as bonds, stocks, and treasury bills. Recently, the rates on treasury bills have increased, making those more appealing to more risk adverse investors. T-bill rates impact real estate income yields as investors then expect higher returns when compared to the benchmark of a riskless investment.

REITs are an alternative source of offsetting risk by investing in portfolio holdings and different asset types. Many of our clients are REITs and have positioned their success on the ability to purchase our value-add retail listings thereby increasing yield.

What is the future real estate outlook?

Using some of these indicators we make more informed predictions about the future of expected returns. While purchasing real estate always entails some risk, it also comes with reward. From at least 1985-2009, real estate investments exceeded the rate of inflation and produced investment returns. Increasing returns is also a hedge against concerns about inflation. While uncertainty in the market can be a factor affecting values, knowing how to analyze the trends can help offset volatility.

Our team is uniquely qualified to walk investors through multiple retail assets from single tenant, multi-tenant, to grocery anchored power centers and properly position dispositions ahead of the market curve.

The Real Estate “Occupy Movement” : The Last 10%

The Occupy Movement

The Occupy Movement started in 2011 when an activist blogger in New York started a Tumblr post entitled “We Are The 99 Percent” with a focus on income inequality, among other things, and spawned the Occupy Wall Street and other Occupy events at that time. The blog was inspired in part by economist Joseph Stiglitz’s May 2011 Vanity Fair article “Of the 1%, by the 1%, for the 1%” where he observed that 1% of the US population take home nearly 25% of the nation’s income, and control 40% of the nation’s wealth.

Occupying the Last 10% in Retail Shopping Centers

This blog post is about another Occupy Movement that preoccupies every owner in our industry, and that is the push to get all of the GLA occupied in our centers. Occupancy equals cash flow and value, the end game of the ownership of real estate.

When I worked as a portfolio manager for a shopping center REIT, our COO had a saying that has stuck with me to this day, “Every dollar a day sooner.” He said that to keep everyone’s focus on getting our vacant spaces leased as soon as possible – to limit downtime, and to push for maximum lease dollars. This is the job of every owner.

The Cash Flow Impact

Every square foot of retail space is worth anywhere from $0.50 and $4.00 per square foot per month, depending on the market, and location of the space within the center. So, a 1,000 SF space is worth anywhere between $500 and $4,000 each month. And NOT leasing that space “costs” its owner $500 to $4,000 per month. Adding in NNN charges (typical for most leases), the opportunity cost moves to $950 to $7,300 per month, equating to anywhere from $11,400 and $87,600 per year.

I don’t know many people who would not want the opportunity to have additional cash flow like this!

There are mitigating circumstances that may make it difficult to get every square foot leased, but the goal of every owner is to lease up vacant space.

For instance, an owner with 5,000 SF of vacancy in his or her portfolio, with rents of $15 PSF annually, and NNN costs of $3 PSF, leasing the vacancy brings in $90,000 extra income. For 20,000 SF of vacancy, and rents of $20 PSF (and NNN costs of $3 PSF as an example), that adds up to $460,000.

The Value Impact

This additional income has a far greater effect on value.

Using a 6% cap rate as the “market” for valuation of a center, the impact of leasing space is as follows (market rents across the top row, GLA leased along the left column):

SF/Mkt Rent $5 $10 $15 $20
5,000 $670,000 $1,080,000 $1,500,000 $1,920,000
10,000 $1,330,000 $2,170,000 $3,000,000 $3,830,000
15,000 $2,000,000 $3,250,000 $4,500,000 $5,750,000
20,000 $2,670,000 $4,330,000 $6,000,000 $7,670,000

As one can see, that additional cash flow has a huge impact beyond the immediate cash flow benefit. This impact is not only affects a sale, but also affects financing proceeds, and in most cases, financing terms. Lingering vacancies can be perceived as market weakness, or a functional problem with a certain space, however it may be perceived as sponsor (borrower) weakness and affect loan terms. Not always the case, but one wants one’s best foot forward at all times.

While some underwriters may still apply a market vacancy factor to a center, beginning at the highest possible number is always the best place to start.

A Solution For The Last 10%

Sometimes it is difficult to get leasing agents to focus on these last spaces in a center. We propose that owners consider contracting a company on a fee basis in order to “stand watch” on these last spaces. This contract amount benefits in several ways:

  1. The amount does not need to be onerously large
  2. The fee could be included in a monthly management fee, to be included in NNN charges
  3. The incentive on the remaining space will be focused on fulfilling the contract obligation and less focused on the leasing fee, which in most cases is small
  4. The leasing firm would welcome the recurring revenue which benefits their EBITDA and value
  5. Having a leasing person paying regular attention to the center may lead to other larger opportunities and will increase ownership’s exposure to market trends

Reach out to our team to discuss your portfolio, including and any lingering vacancy issues so that we can proactively come up with a plan to add cash flow and improve the value to your portfolio.

Top Five Considerations to Make When Purchasing Corporations that Hold Real Estate​

Our team has recently been assigned the task of selling 100% of the shares of an S corporation which holds real estate assets. This opportunity brought up a challenge in assessing the benefits and risks of holding real estate in a corporation as opposed to an LLC or a sole proprietorship, and the tax implications for this transaction.

The motivation for the seller of this corporation is that they inherited their real estate portfolio in a C-corp, and after assessing that situation, elected to convert the C- Corp to an S- Corp. They then faced the issue of selling the assets individually or in bulk, and based on the advice of their legal and tax counselors, elected to opt to sell the S Corp outright.

Advantages and Disadvantages of C-Corporations

Holding real estate in a corporation has various advantages. A C-Corp is a taxable entity, where the corporation itself is taxed on its income (as opposed to other structures which simply pass income along which is subsequently taxed). For those that do not necessarily need to pull all of the net income out of their corporation, the C-Corp provides for keeping cash in the entity. It also provides the benefit of income splitting, where the business’s income is split so that part of it is taxable to the corporation and part of it is taxable to the owners of the corporation. However, C Corp taxation is such that distributions are subject to double taxation, where the corporation is taxed on its income, and the shareholders are taxed on the dividends received.

The Tax Cut And Jobs Act has invoked recent changes to the US tax code, and has reduced the corporate tax rate from 35% to 21% thereby reducing the deductibility of state and local income tax payments in determining federal income. Now that this code has passed into law, the advantages for some Real Estate Investment Trusts (REITs) to convert to C-Corps is starting to have “legs.” Most times, this involves a simple measure of becoming a Real Estate Operating Corporation, or REOC. What this means is that REITs, which ordinarily must distribute 90% of their net income as dividends, may find it advantageous to de-REIT and become a C-Corp. REITs that would benefit from this change would be those that have assets that have lease up/rollover risk, require capital expenditures, and/or need to be redeveloped.

The REIT structure in this instance puts the company at the mercy of the market, and requires the sale of assets to to raise capital. REOCs benefit from this structure as they can self-finance their expansion, and can retain capital and reinvest it in a more tax-efficient way, and in a manner that is consistent with the nature of real estate.

REITs that do not need this structure are those that own triple-net assets, self-storage and, in some cases, health care properties. REITs that would benefit from C-Corp conversion would be those that own malls, large shopping centers with redevelopment needs, and office properties.

S-Corporations Versus LLC Ownership

The S-Corp holding manner has some tax savings as profits from the S-Corp are not subject to self-employment tax. However, the S-Corp still must pay any owner-employee a reasonable salary which is subject to Social Security and Medicare taxes. S-Corps are significantly more complicated than LLCs and require more professional input, meaning billable hours for accountants and attorneys.

Ownership as an LLC has no tax advantages or disadvantages. In California, LLCs are subject to franchise taxes in addition to typical income taxes. LLCs, particularly single-purpose LLCs, are also the preferred method of ownership for lenders, and in some cases absolutely required.

Purchasing a Corporation

In purchasing a corporation for the purpose of controlling the underlying real estate assets, one must understand that this transaction differs significantly from a straight real estate transaction in many ways; namely, taxes, financing, and ultimately, value.

  1.  The purchase of the corporation does not qualify for a tax deferred exchange. Trade dollars can be used, but the purchase would not qualify for a 1031 tax deferred exchange. This does not affect value directly, but limits the utility of the transaction for the buyer.
  2.  The sale is, in effect, a change of control, which may trigger issues with loan covenants (if there is debt on the portfolio) and in California, reassessment of real estate property taxes.
  3. The purchase of the corporation can be financed as a corporation purchase which may or may not have the same metrics as financing for straight real estate purchases. Overall loan dollars will be affected by the valuation of the corporation itself, which may or may not follow the underlying real estate assets. Some lenders may only offer credit lines for these transactions, and some lenders limit the loan dollars to a lower loan-to-value ration on the purchase. However, some lenders offer more dollars on a refinance, so structuring a transaction with bridge financing to be taken out as a refinance later may be beneficial in this instance.
  4. The basis by which capital gains are computed does not change in the sale of the holding corporation. This means that there is no “step up” in basis, and the original basis follows. Also, depreciation is inherited as well, and does not re-set. This must be properly reviewed by one’s tax and legal professionals.
  5. The acquisition of the corporation will put you in the place of the former principals, including responsibility for liabilities. One must fully explore the potential liabilities that might be inherited. If the corporation has been carrying “per occurrence” insurance, that insurance is supposed to cover claims made in the future for anything alleged from the past. This should be carefully reviewed with the insurance carrier during due diligence, as well as legal counsel. Also, full due diligence on all prior activities should be done, and as an additional measure of safety, an umbrella liability policy might be in order. This is the stuff that makes careers for insurance and legal professionals, and definitely consult both to fully understand the issues.

Purchasing a corporation has benefits and risks. Carefully explore both before launching into the venture. Please also feel free to reach out to a team member to discuss further.