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Market Conditions

Leasing Markets Are Not Created Equal

People are always asking me “how is the real estate market these days?”  Well, I explain, that depends on whether you are looking at residential or commercial; after we narrow it down to commercial, are they asking about investment or leasing?  Zooming in on leasing (which is my area of expertise), there are clearly different answers to their question depending on the type of real estate (retail, office or industrial) and where you are looking.  So here is a quick overview:

Office – Silicon Beach continues to be a submarket in great demand with low vacancy rates and high rents.  The technology economy is driving most office markets (that is, growing the most new companies) and is positively impacting many other submarkets including Culver City, El Segundo, and Hollywood.  Downtown L.A. is seeing some of these benefits, too; however, except for some pockets like the Arts District, downtown is still vexed by a relatively high vacancy rate (around 17%).  The best office deals can be found here.  The Tri-Cities submarket (Burbank-Pasadena-Glendale) are in a healthy state of equilibrium with rents growing modestly year over year.

Industrial – This market segment has never been tighter.  Vacancy in Los Angeles and Orange Counties is hovering around 2%.  Demand continues to be greater than the ability to build new buildings due to the shortage of available land priced appropriately for industrial development.  And yes, rents have gone up commensurately, on average 100% from rental rates about 5-7 years ago.

Retail – the reports of the collapse of bricks and mortar retail have been greatly exaggerated, to paraphrase Mark Twain.  What is changing however is what retail segments are growing and which are shrinking.  Hospitality (food and beverage), entertainment, and personal services are expanding.  Apparel and other merchandise is ebbing.  The toughest thing to figure out is whether the ultra-high rents in the most prestigious neighborhoods  like Beverly Hills, Brentwood and West Hollywood are really supportable.  Paying $15.00 per square foot per month on Canon Drive in Beverly Hills is not a guaranty of success!  In retail more than in the other market segments, property owners have visions of grandeur and are asking rents higher than what is sustainable for tenants.  Nowhere is this more apparent than in the reinvigorated neighborhoods of downtown L.A.

In summary, the strong economy is pushing up demand and rents in its wake.But there are still good deals out there if you know where to look.A good commercial real estate broker can provide the guidance essential to making a smart decision.I am available for a little free advice

Patience is a Virtue

It is an interesting commercial real estate market out there.  Office space is careening toward co-working spaces and creative expressions while vacancy rates range from 7% in Santa Monica and 17% in downtown Los Angeles (guess where the better deals are!)  The retail landscape is shifting from merchandise to service and hospitality but no, the shopping center is not dead.   Think of retail real estate like an open bed tomato truck: the industry is taking a sharp right turn and some of the tomatoes on top will fall out and make a splatter on the pavement but most of the load will make it to market. 

The real surprise is industrial, that boring mule of commercial real estate.  Vacancy rates in Los Angeles and Orange Counties are currently below 2%.  That’s right…2%.

There are a multitude of reasons for the tight conditions: old industrial buildings are being redeveloped as apartments or repurposed as creative office – think Silicon Beach and the Arts District in downtown L.A.  With the supply of undeveloped land naturally shrinking, industrial land is being priced out of the range that makes sense for industrial development.  And staring this shrinking inventory in the face is increased demand from “last mile” distributors fulfilling the delivery promises of Amazon and other merchants trying to compete.

The guidance I give my clients is to be patient.  If we don’t find the property that suits your needs on our first dive into the market, don’t panic.  My job is to keep my ear to the ground and scout properties as they become available.  But when they do, don’t hesitate!  I reported to one client looking to move their film industry special effects firm to Pasadena that a space had come up in a location they really liked.  The client said “Great…I’m leaving town for a week but when I return, let’s take a look.”  By the time he got back to town, the space was leased. 

The role of a good tenant rep broker is to educate his or her clients on the reality of the submarkets they want to be in.  If you are looking in downtown L.A. for office space, you have tons of choices.  If you’re looking for a warehouse space in Glendale or Torrance, be sure to budget in an extra month or two to find it. 

Keep it real and do the deal.

Should I Lease or Should I Own?

The economy is growing at a good clip and businesses are getting their mojo back.  The commercial real estate market is in a nice state of equilibrium.  Commercial landlords are getting decent rents and tenants can afford them.  But in the continuing low interest rate environment, many business are tempted to buy instead of lease.  After all, why should they pay so much rent if it is economically advantageous to own their own building?  Good question...complicated answer.

The economic factors that work in favor of ownership are very alluring and real: saying goodbye to rent increases and property tax surprises (when a landlord sells the building where you lease), control over building operating expenses, and depreciation.  An experienced commercial real estate broker should have the tools to plug salient data into a financial model and quickly analyze whether leasing or buying is to your advantage.  But there are several factors that your broker needs to run you through to see if you are really ready, willing, and able to be a building owner:

  • Buying a building requires capital for an equity down payment.  Think about the opportunity cost associated with those dollars; in other words, what could that money be earning you if put to other business purposes, i.e. new equipment that generates higher production output?

  • If you are considering buying a building that is larger than you need (SBA financing requires that the borrower occupy just 51% of the building), are you really prepared to take on the leasing risk and the property management responsibilities?

  • What is your exit strategy?  Will the building or commercial condominium be easy to sell on the open market, with or without your business inside?

 

These are complicated issues that should be talked through in detail with your real estate advisor.  No matter what your motivations are to buy, once you own, you are in the real estate business.  Think this through...do you want to be?

If you or one of your clients are evaluating whether to buy or lease, call me.

When a Sublease Might Just Be the Answer

A business looking for a good real estate deal should always be open to a sublease.  This arrangement can be a bit complicated because it is really a deal between three parties: the tenant currently occupying the space, the landlord who must approve the deal and the subtenant.  But the economic advantages can easily outweigh the aggravation of getting all of the parties aligned.

When negotiating a lease, the property owner – the landlord – is first and foremost concerned with the value of their property.  The rent rate negotiated translates into net operating income and that is a key factor in calculating value.  This is why landlords will offer free rent in order to keep the rent rate as high as possible.

For a tenant looking to sublease, their focus is on cash flow: finding a subtenant to cover all or most of their remaining rent obligation.  Negotiations with a tenant trying to sublease their space will be focused  on their anxiety over paying rent for a space they are moving out of.  The pressure is on to find a subtenant as soon as possible and stanch the bleeding.  And a good broker should have the skills to leverage that anxiety to get the deepest discount possible in return for providing the immediate relief of  a paying subtenant.

There is an important caveat that brokers should always tell their clients in this situation:  that great sublease rate you were able to negotiate with the tenant might well go up when dealing with the landlord when you want to extend your lease at the property. 

To summarize, when you’re considering a sublease, both carpe diem (seize the day) and caveat emptor (buyer beware) apply.  

Deploy Your Crystal Ball For Real Estate Planning

As a professional commercial real estate broker, I have come to the heartbreaking realization that my clients just don’t think abouttheir real estate every day; indeed, they think about it only when they absolutely have to.  The problem is that real estate decisions sneak up on you and then you find yourself with limited time to make them, and limited choices.

Don't Be Paralyzed by Fear

In every lease I negotiate, I find my years of experience managing properties for the landlord of immeasurable value.  My understanding the landlord’s business guides me to negotiate where I know I can get great results for the tenant and helps me set the tenants expectations where I know the landlord will be immovable.  This varies from deal to deal and an experienced tenant rep broker can tune in to the economic forces at play in every situation.

One of the more challenging terms to negotiate is the rent for future renewal options.  Most landlords default to “fair market value”.  I always try to fix the option rates for my clients, but sometimes the landlord digs in his heels and the best I can do is negotiate in the lease language to insure “fair market value” must be arrived at fairly and cannot be set arbitrarily by the landlord.   As lease terms get longer and options are further out in the future, it is time to concede that “FMV” is really just fair to the landlord.  I have to explain to my tenant clients sometimes the fundamental principle of the landlord’s business: with the risks they assume when they invest in property, they are entitled to reap the rewards of an improving market. 

 I had a client who was looking to lease retail space in downtown L.A.  We negotiated a ten year lease and managed to cap the rent increase for the first five year option, but the landlord held firm on FMV rent for the second option.  We are talking about 15 years down the line.  The tenant was mortified.  “The landlord could double or triple my rent!  I can’t stand it!”  I had to talk my client off the ledge.  I did so by explaining that fair market rent is what a reasonably successful tenant can afford to pay on a sustainable basis.  To set the rent at a higher level only guarantees that the landlord will have a failed tenant and a vacant store.   And if this client’s business was still in this location 15 years from now, chances are he is operating a reasonably successful store!

Risk is inherent in commercial real estate whether you are a landlord or a tenant.  Don’t be paralyzed by irrational fears.

The Complex Economics of Choosing a Location

When you ask most businesses what first comes to mind when you say the two words “location” and “economics”, they might answer high rent versus low rent.  This answer is on point and shows up right on page one of the lease.  But stopping the analysis there could be a costly mistake.  There are many aspects of location that can have a real impact on your economy – your business’ bottom line.   

The City of Los Angeles has its gross receipts tax – a controversial charge levied on all businesses operating in the City at varying rates up to 5%.  That top tier will be reduced to just 4.75% in 2016.  Oh, happy day!  That alone might motivate you to consider other surrounding incorporated cities like Burbank, Pasadena, Glendale, El Segundo, Culver City, and West Hollywood.  On the other hand, the city, bowing to this competitive disadvantage has established a three year moratorium on the tax for new businesses starting in or moving to the City of Los Angeles.  Indeed, there may be very compelling reasons to locate in downtown L.A. or Century City, but it’s always best to be forewarned and to include city taxes in your occupancy cost analysis.

California’s Proposition 13 has been on the books now for 37 years but remains a double edged sword for commercial real estate tenants.  Given that increases in real estate taxes are passed through to tenants in most cases, the cap on year over year property tax increases set by Prop. 13 is a blessing.  But you can get blindsided by huge increases when the property you are leasing is sold and reassessed.  How to protect against this?  Have your broker research how long the current landlord has owned the property.  If it has been more than 10 years, the increases in the event of a sale are likely to be big.  And do not believe the landlord or their agent when they tell you that they plan to hold on to the property forever.  It’s an all too familiar refrain that you cannot hold them to!  

It pays big time to have an experienced real estate broker in your corner bringing up these challenging issues and advocating your best interests when negotiating your lease.  

Two heads are better than one and might just spare you a migraine.

The Market Dictates, Not The Landlord

In a previous edition of Lease Intelligence, I touched on the challenges of seeing through proclamations made by the landlord or their agent about the value of their building and getting to the real deal.  This prompted a number of comments from readers including “how can you tell the difference between their proclamations and the truth…and what are the cues?”

There is no fairy dust or magic wand that comes with a real estate license or an advanced commercial real estate designation, such as CCIM.  The weapon that cuts through the landlord’s bluster is nothing more than solid research, preparation and experience.  If the landlord’s side tells the story of the top of their submarket, your broker should counter with the bottom of that same market.  If the landlord’s line is “The market has gotten tight – no more free rent” your broker needs to cite a recent deal that came with several months of free rent.  True, no two deals are made in the exactly the same circumstances but your broker should know how to leverage the facts to your advantage.  The objective is to neutralize the landlord’s claims – or their ego, just in case they really start believing their claims as unassailable truth.

Once the landlord’s side hears the sharp “clink” of your advocate’s sword striking theirs, the posturing shifts and the parties start to search in earnest for where the deal really is.  Think of natural market forces like the referee in the duel.  The objective is not necessarily to slay your opponent but to come to a fair, balanced outcome. 

Good, old fashioned preparation.  And a sharp blade of hardened steel.

Facing Your Fears - Buying in a Hot Neighborhood

So you want to buy a building in El Segundo?  Talk about a submarket that went from sleepy to Silicon Beach in a heartbeat!  Like the Arts District in downtown Los Angeles, the small industrial buildings in its cozy neighborhoods have a huge appeal for creatives.  (I mean, who wouldn’t want to call “Smoky Hollow” – a funky 15 block enclave along the southern edge of the city – home?)   New ideas seek a new neighborhood.   Creatives want to create their universe.

Needless to say, values have shot up and every building owner has stars in their eyes.   There are real and there are false indicators of value in a resurgent neighborhood.  Be careful.  Don’t buy without an experienced, sober broker working on your behalf. 

First of all, accept the fact that a hot neighborhood is a seller’s market.  There isn’t much negotiating on price but even in the hottest neighborhoods, there is a range.  Some factors clearly weigh on a property’s value.  For example, parking can dictate whether an industrial building is a viable candidate for adaptive use to creative office.  If the site is tight, a good broker can persuade the seller to consider a price at the lower end of the range and can press for more flexible deal terms. 

Ultimately, it is the energy of the people and businesses migrating to the area that creates relative value.  Does that transformative energy matter to your business?  If not, I can find you a building in Gardena that is much cheaper.  Are the businesses migrating to the street creating a critical mass that will embody a unique culture and panache to the address?  That might be crucial if hipness makes you more competitive in the race to recruit top creative talent. 

The big question that keeps buyers awake nights is “will it continue to appreciate?”  Buying to make money on real estate frontiers is for visionary risk takers who get into these neighborhoods early when naysayers think they are crazy.  Buying when the resurgent neighborhood is in full swing must be for sound reasons related to your business.   The upside will take care of itself.