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.

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.