Last week, we spent some time discussing the morphing industrial market and its impact upon pricing.
To review, north Orange County — especially in large logistics boxes — approaching an imbalance weighted upon those who occupy. Supply exceeds demand. Only time will tell if price drops will spur demand, also known an elasticity.
With that backdrop, today I’d like to offer some suggestions if you find your company heading out to make a deal: either a purchase but especially a lease.
Know the market
Let’s say your requirement is 100 to 150,000 square feet of logistics space in North Orange County. You should be keenly aware of everything that currently exists or will become available during your search time.
By this, I mean, what tenants will vacate spaces that you could backfill. Coupled with an understanding of the available inventory is knowledge of the transactions that have recently occurred.
By the way, transactions occur as sales, direct leases, subleases, and renewals. Sales are a matter of public record — their terms are easy to determine. Direct leases and subleases are more difficult to track because no deed is recorded. Renewal deals are the most difficult to review, as frequently renewal deals occur between an owner and his occupant. These are typically not marketed and therefore difficult to gauge.
It is imperative that you engage a commercial real estate professional, who really understands the marketplace in which your requirement will compete.
Another factor with which you should be aware is the type of owner holding title to the property. An institutional property owner such as a pension fund adviser or a real estate investment trust will likely have more guard rails around the terms and conditions under which they can negotiate.
A private owner may be more flexible in agreeing to favorable terms. Regardless, you must understand the owner’s motivations in order to secure the best possible sale price or lease rate and terms.
Know your capabilities
Here are some options you should seriously consider:
—How long you will be able to commit to the space?
—What variances from the typical amenities will you require?
—What is the timing of your present lease expiration?
—Do you own a facility that must be sold prior to transacting?
—Is there anything unique about your use of the building that might cause a timing delay?
We recently represented a tenant who was able to sign a 10-year lease, use the improvements in the building largely as they existed, and had a lease that expired with enough time to enable the building to become market ready. We were an ideal match for the owner. Had any of these components been lacking, our requirement would not have been as favorable.
Understand your strong suit
If your company is ready to move upon closing a sale or signing a lease, and the building you are pursuing is vacant, you are potentially golden.
However, the converse could be true if you are ready to make a deal, yet the building won’t be available for another nine months. As you can see, something would have to change with this set of circumstances.
Either you would have to delay possession or the owner would have to figure out a way to make the building available sooner. Is your company financially strong?
In this rapidly changing market, credit is king. The last thing an owner wants to do these days is sign a long-term commitment with a financially shaky occupant. Turnover is expensive, and owners want to avoid this at all cost.
Be aware of your blind spot
If all the interest in a particular piece of property were laid side-by-side, how does your interest compare?
Do you require bank financing in order to complete the deal? Is board approval a part of your process? Is there anything particular about your requirement, which could add time to your ability to say yes? Will a hefty legal review of all the documents ensue upon the handshake? How does the purchasing or leasing entity look financially?
Let’s say you want the very best purchase price available yet are hamstrung because of your need to procure financing. This adds an uncertainty to the transaction which may cause a seller to go a different direction.
Of course, this assumes there are other potential purchasers. If your sense is you are his only alternative, you may be able to get a great price and the timeframe needed to close the deal. Certainty of clothes these days is more important than the very highest price. Consequently, structure your deal accordingly.
Don’t get greedy
The biggest mistake I see occupants make in this rapidly changing market, is trying to take advantage of an owner. Owners of commercial real estate are generally sophisticated entities with tons of market expertise. It’s safe to assume they’re acutely aware of their situation.
If you are trying to extract the best sales price, lead with data. By understanding the owner’s exit strategy – lease up and sell or hold long-term, you can chart the course to completion.
Using the lease up and hold exit, an owner will have to procure a tenant for his building before selling it to an investor.
Therefore, understanding the rental market — rate, concessions and terms — you have a starting point. Once a tenant is in place, what is the market capitalization rate for this income.
Assume $21.60 triple net annually and a 6% cap. The resulting price per square foot value would be $360 ($21.60 divided by 0.06). But the tenant is not there yet. So, it would be reasonable to expect some origination costs should be subtracted.
After all, to procure the tenant will require some free rent, potential modifications to the building such as lighting or dock levelers, and brokerage fees. To compute this cost requires assumptions. Overestimate and the greed enters the picture.
Thus, negotiating the best deal in today’s industrial real estate market requires thorough market knowledge, a clear understanding of your capabilities, and strategic negotiation. By focusing on data-driven decisions and avoiding greed, you can secure favorable terms in a challenging market.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.
