Who to affiliate with?

 A student of mine asked me how to choose what real estate firm to affiliate with. It is best to interview with a number of different types of companies to see what the best fit is for you.

 There are certainly a number of things to consider. Some firms ask each agent to specialize, become an expert in a particular segment of the market, office leasing or industrial sales or perhaps retail site selection.  This is fine but sometimes a segment of the market slows down, and there is no activity in your field, and you make no money that year.

 Other firms cross-train the agents to handle whatever opportunities they may encounter. In these offices the specialization is geographic, becoming an expert in that market area. This concentration gives you a better opportunity to systematically meet all the business owners, tenants and landlords in your area. Ideally to become known as the local “Commercial Specialist”.

 Do you want to be a full-time commercial agent or a dual practitioner doing both commercial and residential work? Some companies are strictly commercial, some do both disciplines. In some of the firms that do both there may be a “commercial division”. There can be advantages to both situations.

 In a purely commercial company, there may be a mentoring program, perhaps working with an experienced agent for a period of time to gain experience. Commissions would initially be split with your mentor, being your price to learn the business.

 This could occur in a dual office too, but the other advantage of this type of office is the commercial agents can get referrals from the residential agents in their office. Being a dual practitioner may lead to commercial opportunities, servicing your buyer’s business or investment needs after selling them a home.

 Commercial brokerage is very different from residential. I think of a residential transaction as a one-shot deal, one client, buying one house, one time. Granted they may give you referrals and you may be able to service them again if they need to move.

 Commercial gives you multiple opportunities for future business. You lease space to a tenant for five years, can you service the client again when their lease is up? If you’re not in touch and call them up four and a half years later, probably not. But if you stay in touch during their lease, calling or stopping by every few months, you should be able to service them again. Also consider businesses grow, shrink or go out of business, you can help them when any of these things occur.

 Communicate regularly with their landlords of the buildings you placed  tenant in, who may have other tenants who are not renewing their lease, or they may want to buy another investment property, or sell this one. The beauty of commercial real estate is the opportunity for redundance.

 In either case you need to be trained for the discipline you choose. Online and virtual courses are available, as are many books on all facets of real estate. Knowledge leads to success. Real estate markets are constantly changing, training and updating your skills never ends.

 Should you work with a small firm or large firm? Another key consideration is what kind of training and support, if any, will be provided. In a smaller firm the Broker may be very busy and have little time to train new agents. They may also have their own clients and be in competition with their sales agents for new business.

 Other firms, especially the larger companies may have corporate training programs and educational staff just for this purpose. They may have brokers who manage the business and assist their agents, but they are not permitted to have clients of their own, all leads are passed through to the agents.

 Ask about the company’s websites and marketing tools. Who makes your listing flyers, you or staff?  Is there staff? How are your listings advertised?  Today there are many commercial websites, which charge for subscriptions, do you pay or is the firm paying for the subscription. Bottom line who pays for what?

 The compensation issue – how much of the fee do I get?  This varies considerably, some firms start out with a 50-50 split of the commission and as the agent’s production increases, they get a higher percentage of the fee. Other firms offer 70%, 80%, 90% or more of the commission to the agent. But usually in these cases there are monthly costs to the agent for operating expenses or marketing funds. These monthly fees can be considerable and must be carefully evaluated. Be very clear on all of the firm’s policies, about everything.

 Your market – where do you have the best opportunity? What Brokerage firm(s) is/are dominating your area? If you join them, will you be able to shine or are they overloaded with agents now?

 When considering joining a firm, interview with the Broker and speak with some of the other agents working there now. How are they really doing? What kind of support or training have they gotten? Interview with several companies determine their structure, training, splits and your opportunity for success.

How banks look at Commercial Real Estate (CRE) loan requests

 Initially when applying for a commercial mortgage on investment property the bank requests a copy of the Income and Expense Statement and a copy of the purchase contract.

 They may want to see last year, or several years back, Income and Expense Statements and the current one which is a projection of how the property is expected to perform this coming year. This is also known as the Operating Statement or Proforma.

 The current statement will show the income from actual tenants and project income, based on current market conditions for any space temporally unoccupied. It will also make an adjustment for the possibility of Vacancy or Credit Losses. Adding to the statement any other income to the building not from the tenants (antenna on the roof, billboards, vending machines etc.). This gives us the Gross Operating Income for the property.

 Next the owners operating expenses will be subtracted, including a contingency for emergency repairs which then provides the anticipated Net Operating Income (NOI) for the current year.

 Banks process thousands of commercial loan applications and as the do so, they see trends which are reflected the Capitalization Rates (CAP Rates) they use in analysis. CAP Rates reflect local geographic real estate activities and are prone to gradual change. They will determine, based on actual closed transactions, a pattern for each investment category: office, retail, industrial and multi-family. Then divide the Net Operating Income by the price paid and determine the CAP Rate for that transaction. Patterns emerge indicating what is an acceptable return for investors (CAP Rate) in that particular market, at that time. Banks use these trends in determining if a new loan application will be approved.

 For example, if a property had a NOI of $60,000 and sold for $750,000 would reflect an 8% CAP Rate

 $60,000      =    8%
$750,000

 With this information the banks determine their opinion of value, for mortgage purposes, of a property by dividing the NOI by the CAP Rate they are currently using for that class of properties.

 Next, they will underwrite the property to determine what is called the Loan-to-Value Ratio (LTV). Historically commercial banks have required a downpayment of 30% to 40% of the purchase price. This is done by dividing the requested Loan Amount by the bank’s opinion of value which equals the LTV. An acceptable LTV would be 60% to 70%.

 Banks look at the worst case scenario. What if we make a loan and the borrower defaults and they have to foreclose on the property. This would allow them to quickly sell the property at less than market value to recoup their losses.

 The next step in underwriting is to determine the Debt Service Ratio (DSR) a/k/a Debt Coverage Ratio (DCR).

 There is risk involved in making CRE mortgage loans. What if the building loses some tenants, reducing their cash flow and ability to pay their monthly mortgage payments? If this persists the bank would eventually need to foreclose on that loan and take possession of the property.

 The Debt Service Ratio creates a “buffer”. Banks will only loan out a certain percentage of the Net Operating Income, the cash flow. So, if the building loses some tenants there would still be sufficient cash flow to make the mortgage payments. Today the federal guidelines require a 25% DSR, meaning the maximum Annual Debt Service (ADS is the  total principal and interest payments for that year) percentage would be 75% of the NOI. In fact, some banks today want an even higher DSR of 30%. The DSR is calculated by dividing the NOI by the ADS.

 As an example, an office building has a Net Operating Income of $60,000, the bank is currently using 8% as the CAP rate for office properties.

 NOI  $60,000       =     $750,000 Market Value
CAP    .08 (8%)

 Applying for a Mortgage purchased at an 8% CAP.

30% down payment
7.5% interest rate
20 year amortization
Price $750,000
Down payment $225,000
Mortgage $525,000
Payments $4,229 mo. $50,752 annual

 Debt Service Ratio

NOI $60,000     =   1.18     What is required 1.25 – 1.30
ADS $50,752

 This loan will not be approved. The price would need to be reduced or the buyer needs to put down a higher down payment. The loan amount must be reduced to reach an acceptable DSR.

 If the downpayment was increased by $25,000 to $250,000 the ADS of a $500,000 mortgage would be $48,355 creating a DSR of 1.24. Close enough, no. The FED requires a minimum DSR of 1.25. More down or a lower price is required. Also remember some banks want a higher DSR of 30%.

 If the price were reduced to $700,000, using a 30% down payment, a $490,000 mortgage ADS would be $47,368 creating an acceptable DSR of 1.27.

  In this case if 40% ($300,000) was the down payment a ADS of a $450,000 loan would be $43,502 creating an acceptable DSR of 1.38.

 The underlining problem in this example and today are the high interest rates. They are effectively forcing a reduction in value or a higher downpayment to get a mortgage loan.

Politics and Real Estate

I have voted in many local and Presidential elections, and I encourage everyone to vote. Each day now politics is in the news and on social media. The next Presidential election seems to be continuing as in the past, with strong feelings and rhetoric being expressed by so many people. Congress seems more divided than ever.

Clients are still continuously asking their real estate agents “Who are you going to vote for?”, “What’s your position on…?” This creates a new communication challenge for those of us in the business. We know we must develop trust with our clients, which means being transparent and honest, but will the answer to those types of questions rub the client the wrong way. If we answer, “I don’t talk politics or religion” they may not like that answer either. More than ever, we need to think about what we say.

I once read an article in the Realtor Magazine, “How divisive public discourse is affecting business relationships—and what you can do about it.” by Graham Woods, which addressed some concerns.

Part of the article was basically a caution to agents not to personally participate in social media positions that could affect their image.  “Real estate pros are public ambassadors for their communities, so they should remember that they are representing their business and neighborhoods at all times, and on all forums”. Our success is largely based on the reputation we create.

Marki Lemons-Rhyal, a Chicago-based real estate coach who teaches social media ethics, says “You shouldn’t be a practitioner and shouldn’t have a license if you think, ‘I’ll say whatever I want to say’; remember you don’t ever get to take your real estate hat off. If you get online and rant and rave, about a candidate or policy, that could be sending a message that you won’t work with a certain type of client.”

You may be thinking, this is America, and we all have a right to free speech, which is true. But in our business what we say, especially in public media, can have consequences. At best, you may be losing potential business, but this type of conduct could also be considered a form of discrimination.

Discrimination is defined as making a distinction in favor of or against a person based on the group, class, or category to which that person belongs rather than treating them on their individual merit. We must respect the federal protected classes: race, color, national origin, religion, sex, familial status, handicaps, and most States also protect sextual orientation and gender identity.

Whether you are a real estate practitioner, or a Realtor the National Association of Realtors Code of Ethics cautions us about our public image. It states Realtors shall not deny equal professional services to any person in any protected classes. Furthermore, the Code makes specific reference that Realtors must not use harassing speech, hate speech, epithets, or slurs regarding people in protected classes. This includes all activities, conduct, speech, including occurring outside of the real estate transaction, that is discretionary, such as social media, public statements or just conversations.

I won’t work with you because you’re a Republican, or a Democrat, or because you support _______ or you don’t. Sounds like that could be considered discrimination to me.

Real estate practitioners sometimes must walk away from potential business. In our business some potential clients are prejudice; they want to sell their building or house but tell us “I won’t sell to ______.” (People from a certain country, color or religion) We cannot list their property under those circumstances.

Politics is being discussed everywhere today, in the media, in your office and with clients and customers. You are entitled to your views and opinions, but you must decide if you wish to share them. What messages are your actions or words delivering?

Office Market  Disaster or opportunity?

“Marker Reports” has reported the U.S. market closed 2023 with office sales being 60% less than 2022. In a CNBC interview with Dan Peebles CEO of Peebles Corporation, he cited that, “Washington, DC real estate values are down 60 to 70 percent in commercial office buildings. Los Angeles down 70% or more and San Francisco down 60, 70 percent”. This, decreasing future assessed values of office properties, will reduce the real estate tax revenues for many cities.

In Boston, MA Mayor Michelle Wu is petitioning a temporally increase in the city’s tax rate ceiling for commercial building to deal with the city’s $1 Billion deficit from these plundering office building values. This is being done to be able to continue city services without increasing real estate taxes on residential properties and to insure that homes in the city are affordable.

In Minneapolis, Minnesota, according to a Cushman and Wakefield report 31% of all downtown office space is vacant, largely due to hybrid work models and downsizing of offices. The 31 story, 850,000 square foot American Financial Center is expected to be completely vacant with the next 17 months. It is anticipated the cost to make the necessary improvements to turn the property into a competitive multi-tenant building will be at least $10 million.

Meanwhile the owner of the tower, which is now assessed at $71 million by the city, (which they bought in 2016 for $200 million) will have to pay millions annually in property taxes, energy costs and maintenance while trying to attract tenants. Three office building owners in the city have gotten bids as to what it would cost to demolish their office buildings, with the thoughts that the highest and best use of their properties would be to build apartments on their sites.

The other problem with the market is the high interest rates that are affecting building owners’ ability to obtain loan extensions and workouts and are expected to increase loan defaults and create more foreclosures throughout the country.

Nationwide the office vacancy rate was 18.3% in December 2023.The latest Colliers report indicates office vacancy in New York City has reached a new high in the first quarter of 2024 at 18.1%. Most major cities are struggling with the same problems. The ripple effect on cities is a reduction in the collection of real estate taxes on commercial buildings. This could lead to increasing residential real estate taxes to offset these budget deficits.

According to Goldman Sachs estimates from late 2023, the share of U.S. still working from home is in the range of 20%-25%. The post-pandemic work-from-home, at least part time, seems now to be permanent,and is significantly slashing the need for office space.  

 “Commercial Edge” gives us a good overall view of the market. Nationwide the average office rents are currently at $34.47 per square foot with vacancies at 17.90% and average sales prices at $179.00 per square foot. Below is a chart of a dozen major cities and how they are faring this year, as of February 2024.

This shows us that half are at or under the nation average rent. Ten of these cities have vacancy rates higher than the national average. The average sales per SF varies as it reflects specific buildings sold. Since we have only looked at two months activity, we don’t know how many buildings were sold, is this just reflecting one sale or a consensus of several sales.

But there are a growing group of investors who are looking at the low prices as added value, a “once in a generation opportunity”. Many of these investment companies have been in the business for many years, have experienced varies real estate cycles, and have no doubt these conditions will turn around over time. They are convinced now is the time to invest in commercial real estate.

Black Rock Real Estate Research is of this opinion.  As are SL Green Realty who has announced a $1 billion opportunity debt vehicle and are targeting New York City properties. RXR and Ares Management have formed a $1 billion fund to buy distressed office assets. Ethan Penner and Chad Carpenter launched a new REIT raising $1 billion to fund debt solutions for office owners and investors. Goldman Sachs has a new $2.6 billion fund for commercial real estate lending.

In Don Peebles interview with CNBC he also said, “We’re an opportunity company, so we look to develop when markets are supply-constrained, and then we like to buy when we think there’s tremendous value. And what we’re seeing here in commercial office space essentially is a once-in-a-lifetime opportunity to buy. Nothing like this has happened since the early 1990s…” 

With the current state of the office real estate market, it’s hard to imagine that office buildings will permanently be devalued, and it’s equally hard to think that things will return to how they once were. But what we do know is commercial real estate is ever changing, and it will adapt to new conditions.

Being optimistic, I look at these times as great opportunities for agents and brokers to help the struggling businesses out there, to downsize, if necessary, or to relocate and sign new leases. And to help building owners and investors to sell, buy and/or repurpose their buildings. This is when our clients need us the most!

GREEN Update

 The sun produces radiation, if we get too much sun we get sunburned. Our planet is surrounded by atmosphere, part of which is known as the ozone layer. This ozone layer blocks 90+% of the sun’s radiation from reaching earth.

 We have been burning fossil fuels since the beginning of mankind. They create greenhouse gases, predominately carbon dioxide also known as carbon emissions. The power plants that produce electricity, the systems that heat and cool our buildings, the planes, trucks, and automobiles we use for transportation all create carbon emissions. These emissions punch holes in the ozone layer allowing more of the sun’s radiation and heat to reach our planet.

 The result is an increase in the temperature of the earth and the extreme weather patterns that we are seeing. We are literally seeing the north and south polls starting to melt which increases the depth of our oceans, creating more powerful storms.

Our country and many other countries are finally doing things to reduce carbon emissions. California now has dictated that all new homes be built with solar power. New Your City has created a cap on carbon emissions for all buildings over 25,000 SF, with significant fines if not in compliance.

We now see solar panels everywhere. When the sun shines onto a solar panel, energy from the sunlight is absorbed by photovoltaics (PV) cells in the panel. This energy creates electrical charges that move in response to an internal electrical field in the cell, causing electricity to flow. Solar equipment has come a long way and now makes economic sense.

Solar power is now being used by many municipalities, Rhode Island has set an example by using solar power on all of its State office buildings. RI also passed their Green Buildings Act in 2022 mandating that all State and Local buildings, built with taxpayer dollars, over 10,000 SF must be LEED certified.

 Private companies like Apple have gone solar. Its new corporate headquarters, a 4-story building of 2,800,000 SF, is totally solar powered, as are their huge data centers. One center is 500,000 SF with over 200,000 servers powered and cooled by three adjacent solar farms.

We have seen the many farms that have stopped growing crops and have been converted into producing solar energy.  Now Germany has developed vertical solar panels which will allow the farms to continue to grow crops while simultaneously collecting sunlight to create electricity.

The first vertical solar farm in the U. S. is now being developed in Vermont. It will cover 3.7 acres incorporating 69 vertical rack structures each equipped with two bifacial solar modules, spaced 30 feet apart. The rows will feature crops like carrots, beetroot and saffron planted in between the solar installations.

Indoor farming gives the advantage of being able to grow crops 365 days a year. Metro Crops converted an old factory building in Bridgeport, Connecticut to grow lettuce, kale, arugula, and other produce year-round. In Providence, Rhode Island Gotham Greens converted a former 100,000 SF GE manufacturing plant, where they made light bulbs, into a sustainable greenhouse. They use hydroponics to grow their greens, using less land, less water, and less energy.

 Wind Power started in the Northeast in 2016, with five offshore turbines creating 30 megawatts of power for homes in Rhode Island.  In 2021 two other wind energy projects were approved. The South Fork wind farm will be located 32 miles east of Montauk Point, New York, consisting of 12 wind turbines to provide power to 70,000 homes. The Vineyard Wind project is being built off of Martha’s Vineyard, Massachusetts, and will consist of 62 wind terminals. Construction is expected to be completed in 2024.

 In 2023 the U.S. Department of the Interior approved the Revolution Wind Project also offshore of Rhode Island. This will include the construction of 65 wind turbines to power 250,000 homes. Recently the Interior Department Bureau of Ocean Energy Management approved the construction of Ocean Wind 1, 13 nautical miles southeast of Atlantic City, New Jersey. This will consist of 98 wind turbines and three offshore sub-stations to bring the electricity to shore.

 New York State has recently passed the All-Electric Buildings Act, the first statewide law of its kind in the nation. It outlaws natural gas and other fossil fuel hookups in all new houses and buildings with fewer than seven stories beginning January 1, 2026, and in all new construction by 2029. The end goal being to phase out gas appliances. But there are two problems. The law is being challenged, a lawsuit was filed by 13 plaintiffs including unions, the National Gas and Propane Association and the National Association of Home Builders. The other question is will the power companies be able to provide the necessary electricity?

 We have previously written about the droughts in California and the Southwest. At the end of 2023 and into this year the area has experienced extreme amounts of rain and snow fall, deemed a weather condition called Atmospheric Rivers. This has increased the depth of the reservoirs in Nevada and Arizona considerably but not nearly to full capacity. Concern being for what this summer will bring. California, however, has gotten even more rain, and they are now saying that they expect to be drought free into 2025.

Commission Challenges

Our goal as brokers and agents is to be appropriately compensated for the skills that we bring to the transaction. In simple terms, to be paid a full commission for completing a sale or lease of property. At the point of signing a listing or a tenant/buyer representation agreement is when your commission fee should be clearly stated.

In lieu of the recent National Association of Realtors lawsuit, NAR reminds us, “Compensation is always negotiable. The seller or landlord decides what fee they are willing to pay for their broker’s services and how much that listing broker should offer a broker who brings a buyer or tenant to close the transaction. Compensation is always negotiable, and consumers are encouraged to talk to their broker to understand and agree upon how they expect to be compensated.”

However, if the client then suggests a lower fee, should you concede? No. Think about it. If you reduce your fee at this point, what message are you giving about your negotiation skills.

Rather explain what you bring to the transaction, why you and your company should be retained. People do not know how qualified you may be unless you tell them. What will you be doing to sell or lease or find the required space? Your focus will vary depending upon who you are representing (seller/landlord or buyer/tenant) but generally will include material items and your personality skills and convections.

A partial list follows:

• Market Research – to determine the proper pricing
• Marketing Plan including Internet promotion
• Your resources to find space for buyers/tenants or to list properties
• Pre-qualification of customers – guiding them to determine their specific requirements and financial capability
• Guiding your clientele through the Negotiation Process
• Coordination of all the “players”, appraisals, inspections and environmental tests that maybe required to close
• Your commercial  training and courses you have taken
• Experience - Discuss other properties you have handled
• Promise regular communication.
• Talk about your tenacious personality

You need to create a perception in your client/customers mind that differentiates you from other agents. Show the value of your services, to justify your fee. Remind them that you are making a commitment; you are investing your time and only get paid when you close.

Make sure your listing agreement clearly states your firms commission rate. When you make an offer create a separate commission agreement converting the commission percentage to real dollars based on the value of the offer. So, there is no misunderstanding; if they accept this offer this is how much money they will owe your firm for your services.

Sometimes you get a listing and now have an offer to present that is somewhat lower than the asking price. The client says I will accept the offer if you lower your commission by 1% (or more), what do you do? Too often agents just accept the reduction to make the deal. Remember a rule of negotiations is; when someone gives a concession, it is the best time to ask for another concession. Do not be surprised, if you make this concession, when they ask you to reduce your fee even more.

You should just say no and reiterate what you have done to get this offer and why it is fair based on the market conditions. Everyone tries to get the best deal possible and if you justify your “no”, often they will pay your fee. You can also continue to negotiate the price with the buyer or tenant indicating the owner has rejected their offer. But make it clear to the owner you still expect to receive the full commission they agreed to when you took the listing.

There are several other techniques that can be used to reduce the amount of commission you stand to lose. Owners seem to always think in increments of one percent. “I have been authorized by my broker to reduce my fee by 10% to repeat clients.” (That is 10% of the commission rate previously quoted which will be typically be less than one percent.) Or use fractions; I am authorized to reduce our fee by a quarter (or a half) percent.

Try converting the commission percentage to dollars, our fee is $50,000; do you realize you are asking us to give up $10,000? Or put that in percentage terms, you probably don’t realize but by asking us to reduce our fee by one percent; you are really asking us to reduce our commission by 20%! My broker won’t allow that.

We work hard for our commissions. Know you will be challenged on your fee when taking the listing and when presenting offers. When asked to reduce your fee, be prepared to say “no” and justify your commission.

Lease Protections for Landlords, Tenants, and Brokers

We still have an unsettled market and safeguards have to be built into leases to address all situations.

Percentage Leases Concerns

They can be set up in three different ways.

Many retailers consider the calendar year as if they bought all of their inventory at the beginning of the year but do not realize their profit until the end of the year. In this case they pay a defined rent each month, but when their cumulative sales reach a certain dollar amount, they pay a percentage of their sales each month in addition to the base rent. This continues to the end of the calendar year and then the cycle starts all over again.

The “natural breakeven” is the point in sales the retailer must reach before a percentage of sales must be paid to the landlord as additional rent. This is determined using the following formula: Annual rent ÷ Percentage of Sales = Natural Breakeven Point.

As an example, the rent is $5,000 a month; $60,000 a year (Annual Rent) and a 5% Percentage of Sales is negotiated: $60,000 ÷ 5% = $1,200,000. When the store’s sales reach $1,200,000 the tenant will continue to pay the base monthly rent plus 5% of that month’s sales as additional rent.

The second way, which is common with mall tenants or larger shopping centers is the tenant’s rent is based on a negotiated dollar per square foot plus a percentage of their sales throughout the entire year. Your rent is based on $35 PSF plus 3% of your sales payable monthly.

The other method is where the tenant only pays a percentage of their sales each month.

In the first method Landlords generally have sufficient base rent for their revenue expectations and the percentage of sales in the second half of the year is additional revenue to them.

In the other two methods, especially the later, Landlords need to protect themselves. They will carefully exam the tenants past sales history and current expectations in considering giving them a percentage lease; as the Landlords income is based on that sales revenue.

In these cases, the Landlord considers the worst-case scenario. What if something unforeseen happens and the tenant’s sale volume declines. They are then not collecting the revenue they need.

Often with a percentage lease the Landlord will insist on a Recapture Provision in the lease, to protect themselves. Recapture provision give Landlords the right to take back all or a portion of their property, by terminating all or part of a lease.

It may be triggered if a tenant does not maintain a specific minimum amount of business; reducing the Landlords anticipated revenue.  A poorly performing retail shop can affect the entire shopping centers image and the businesses of all the other tenants, reducing the Landlords income even further. Recapture allows a Landlord to remove
an underperforming retail store, opening the space for a more profitable business.

The Recapture Provision may also be triggered when a tenant wishes to sublease or assign some or all of their space. Market conditions may have changed, and the Landlord could rent the space for more money by exercising their recapture rights and taking back control of the property.

The recapture clause also protects the Landlord in an instance where the tenant attempts to sublease the property for a profit.

Tenants need protection too!

What if the “Anchor” store closes or if several stores in a shopping center close? This reduces the number of people coming to the center and consequently reduces the other stores’ sales.

In these cases, Tenants need Co-Tenancy clauses in their leases. Co-Tenancy clauses can take many forms but give relief to the remaining tenants. The rent may be automatically reduced to a predetermined level, Rent may be changed to a percentage of sales. Tenant may terminate the lease if the Anchor or other vacant stores are not rented within a certain period of time, or if the replacement tenants’ business no longer “feed” the tenants business.

Sometimes a Landlord has a large amount of space available and rents a portion of it to a tenant. Then another tenant is interested in taking the entire space. As an example, in an Office building an entire floor (30,000 SF) is vacated. The market is difficult, and the space has been empty for too long. A tenant wants to rent 7,500 SF and the Landlord agrees to do so. They move in; but the Landlord would prefer a single tenant for the entire floor. The Landlord has a clause added to the lease Relocation Rights. This grants the Landlord the option to relocate the existing tenant to another space in the building.

As you can Imagin relocation is highly disruptive to the tenants. In this case if Relocation Rights are required, the tenant needs to protect themselves by negotiating several things. Landlord to pay for all moving expenses and necessary Tenant Improvements. Rent to be abated during the relocation period. That the replacement premises should be
equal to or superior to the original space. Also, to allow the tenant to terminate the lease in lieu of relocation.
 

Brokers also need protection.

Lease commissions are based on all the financial gain the landlord receives from the tenant, that the Broker placed in the building. The rent the landlord receives each year of the lease including the escalations is added together and multiplied by the negotiated commission rate to determine the commission fee.

A lease has an initial term of 10 years and an option to renew for an additional 10 years. The broker is paid a commission for the initial term on lease signing. The owner sells the building after five years. After the initial term the tenant exercises their right to stay in the building for an additional 10 years.

Normally, a Broker would be entitled to an additional commission from the original owner at the time of renewal (provided your paperwork states so). But now the building has a new owner, would they be required to pay a commission to the Broker when the tenant exercises their right to renew? NO! The Broker has no contractual agreement with the new owner. Their listing agreement and commission agreement were with the old owner.

To protect the Broker, those documents must contain an Assumption Agreement. Stating that if the current owner sells the building, they will require the buyer to sign an Assumption Agreement (in recordable form) whereby the new owner assume the liability to pay the Broker any future commissions that may come due.

Some lease agreements are written only for the initial term of the lease and do not consider the future. To protect possible future commissions, Brokers should add to their listing and commission agreements the following. That if the tenant they placed in the building decides to extend or renew their lease or buy the building the owner will owe the Broker an additional commission and what rate that will be based on.

The Broker of Record and the Agent involved should be stated in every lease. This provides additional protection should they have to go to court to collect a commission fee.

Creating Business Opportunities

As we start thinking about 2024, we need to set our goals for the year and create plans for how to achieve them. What are your goals for yourself, your family, and your business? It is important to write down your goals, as doing so implants them in your subconscious mind. It helps remind you why you are working so hard.

Real estate is a people business, to be successful you need to meet a lot of people. A great source are residential agents in your and other firm’s offices. Ask them, after they close their sale transactions, to refer their buyers to you. Explain you will pay them a referral fee if you do a commercial transaction with their clients.

Meet with the clients and explain the commercial and investment services you can provide. These people may be business owners or be looking for investment property for themselves or be employees who could introduce you to the real estate Director in their company.

Another part of your referral program is to send out five letters a day, reminding folks from your sphere of influence list, current customers, and prior customer lists, that you are in the commercial and investment real estate business. Ask them for a referral, do they know anyone else that you could be of service to? Add a handwritten P. S. to the letter, indicating how you know them. How are the kids? How’s your golf game? It’s been a while since I sold you the house. Will I see you at the next Lions Club meeting?

Follow this up with a phone call a week later, did you get letter? Did you think of anyone else I may be able to help?  Then advise them you will be sending out a monthly email “newsletter” with community news and obtain their email address. That is the real goal of this program. Once a month, creating a simple email is all that is needed, talking about businesses moving in or out of town and upcoming local events.

With this program you are contacting 1,200 people a year (5 letters with 5 follow up calls each day, 25 contacts a week, 100 a month). It will only take you about 30 minutes a day to write your five letters and do your five follow-up phone calls. Plus, the redundancy of contacting them each month thereafter, will keep you “top of mind”. Always close your
e-newsletter; with: “Did you think of anyone I can be of service to?”

Systematically visit two businesses a day in “your” town, speak with the tenant, 10 a week, 40 a month, 480 personal contacts a year with potential clients. Be sure to catalog their information on your computer and plan to revisit them in a few months.

Ask them who their landlord is and make an appointment to meet with them. Do they have any tenants not renewing their leases, are they ready to buy another investment property or sell this building?

Sometimes the business owner is also the building owner. When you visit have some investment property listings with you, then you can immediately talk to them about another investment opportunity. Also ask if they are interested in selling this building.

Read the classified in your local newspaper. Call 2 FSBO’s a day, make appointments to inspect the space they listed in the paper. When you meet with them, you already know they own the building, so treat them as an investor and show them other investment properties that are available. This is another 10 contacts a week, 40 a month, 480 a year.

(Note: NY agents are currently prohibited from phone cold calls, due to the NYS State of Emergency, to solicit a listing. However, you may call a FSBO if you have an actual client for that space.)

With just these three techniques you are creating over 2,000 new business opportunities each year.

Prospect at least an hour each day to build your future commercial business and to accomplish your business goals.

Where else can you find potential clients? At Chamber of Commerce and Service Club meetings; get involved with your community by joining these groups of businesspeople. Be active, join some committees.

When I first joined a Kiwanis club, they were having a fundraising golf tournament. I volunteered and took the job no one else wanted, signing everyone in and recording their scores at the end of play, as a result I did not get to play. But I got to personally meet just about every member of the club.

When you join these groups, what you want to do is to meet as many members as possible, being active on committees will give you more exposure. When you attend the meetings be sure to sit at a different table each time.

Become the speaker at some of these meetings, talking about what’s happening in real estate in your area or topics like how investment properties are valued. Become known as “the Commercial Expert” in town.

Another way to reach potential clients is by forming a “Leads” group. In the group there is only one person from various businesses. You being the only person doing Real Estate. The other members may include, for example, an Accountant, Office Designer, Moving Company, Lawyer, Architect, Insurance Agent, Property Manager, Records Storage, Office Furniture, Janitorial Company, IT Provider, or a Telecommunications Company.

Ideally the group will be relatively small,10-12 people (to keep the meetings short) and meet for “breakfast” once a month. Each person attending brings two leads, contact information about businesses moving into town, expanding, or relocating. Each person represents a different business, so all may contact the leads and offer their services.

But there needs to be some rules otherwise this may become a social gathering and not be developing new business. If any member shows up for two meetings with no leads they are out of the group and another person from that business field will replace them. Once you have a cohesive group with all participating you will see results.

Simply start by approaching someone you know in another business, select another person or two together and have your first meeting, distribute the rules and a contact information form. Also, at that meeting the group can decide on who else to invite.

Meet as many new people, as possible, every day, this is how you create new business opportunities!

The Shoplifting Epidemic

For the most part retail survived (with some major hits) the pandemic. But, now according to the National Retail Foundation, US retailers are closing stores, cutting operating hours and changing product selections due to an increase in crime. In the industry the loss of revenue from various types of crime is called “shrink”, in 2022 this amounted to $112 billion. This includes internal theft from employees, external theft from shoplifting and organized crime theft for the resale of stolen goods.

Large and small stores are being targeted; from Target, Nordstrom, Dick’s Sporting Goods, Walmart, Best Buy and Macy’s to CVS and Walgreens stores. The organized crime and violence that come with it are endangering employees and customers. Best Buy’s CEO Corie Barry stated the company is being force the lock up high price items and this is “Traumatizing our Associates and is unacceptable”. They are closing 20 stores this year. Home Depot CEO Ted Decker echoed the same thoughts, “This isn’t the random shoplifting any more”, it has turned into organized retail crime.

As a result of “shrink” Walmart closed four stores in Chicago and one in Portland. Target is closing 9 stores this October including one in Harlem, New York City, 3 in Seatle, 3 in San Francisco an 3 in Portland. Macy’s in 1^st quarter 2023 closed stores in California, Colorado, Hawaii and Maryland. They plan to close 125 stores within the next 3 years due to the increase in organized retail crime and the high coset to curtail it; more security guards, updated cameras and surveillance systems.

CVS is shutting 900 stores by 2024, Rite Aid is closing 500 stores and considering bankruptcy all due to rampant shoplifting. A CVS store in the DC area has been attacked daily by a gangs of children who routinely strip the stores of merchandise. Street vendors are paying people to go in and steal stuff so they can resell it. These groups of teens, like 45-50 or more, walk in before and after school and at night even stealing food and drinks, which they stomp into the ground outside. The store will be closing.

The number of people in malls has gone up, but the retail sales are still down. Some malls have become gathering places for young adults who frequent casual restaurants and meet with their friends. Also, mall stores are not  immune to the shoplifting issues and many individual stores and the malls themselves are adding additional security personal.

Positive Innovations

On the positive side stores are re-evaluating their space needs and what to do about it. As an example: Kohl’s is now leasing space within their stores to Sephora, Target leases space to CVS pharmacy’s. Pharmacys and banks are now commonplace with grocery stores. These concepts fill surplus space in the host store and create another traffic draw to the location.

Macy’s looking at dwindling mall traffic and bustling suburbs, will be closing existing stores in malls. Their Chief Stores Officer Marc Mastronardi said that small-format stores are part of the solution. They intend to open 30 stores in strip centers which will be one-fifth the size of their traditional mall stores. The stores will offer a slimmed down mix of merchandise, host local events and have a modern open look. Pairing with existing big-box stores, grocers, and popular off-price retailers like T. J. Maxx, in places that have existing high traffic. The stores will be 30,000 – 50,000 SF and 12 are expected to open by the end of 2023.

Rebirth of Toys R Us
In 2017 Toys R Us went out of business. They have just announced plans to open 24 new stores in the U.S. next year, citing their “Air, Land and Sea” expansion. Their marketing plan is unprecedented for a retailer; they will be opening small stores in airports and on cruise ships.

They are hoping to revive their customer’s emotional bond with the TRU brand, Geoffrey the Giraffe, and its jingle, “I don’t want to grow up; I’m a Toys R Us kid”.

Changing the Malls

A JJL survey in June 2023 of 135 malls across the country that are planning redevelopment it found 53.6% include adding housing.

The following is quoted from a New York Times Article
“Facing an existential crisis over empty space, owners are trying to fill malls with residences, building on the live-work-play model sought by young adults.

Seeking to give the Westlake Shopping Center in Daly City, Calif., a town square vibe, Kimco built a main street through it and added more dining options. Credit...Kelsey McClellan for The New York Times

The Westlake Shopping Center, which opened in the 1950s in Daly City, Calif., is one of the first modern malls in the country. It is currently owned by Kimco Reality, based on Long Island, New York, who owns over 500 shopping centers throughout the country. Over the past seven decades, this mall has survived the rise of online retailers, the shuttering of anchor stores and operating restrictions related to the pandemic. Now comes its latest test: the addition of nearly 400 apartments.

The strategy, which is being closely watched by retail experts, is expected to increase foot traffic and generate more revenue from the new residents who may be more inclined to shop in their own neighborhood.

“They’re able to feed off each other,” said Conor C. Flynn, chief executive of Kimco Realty, the real estate investment trust that owns Westlake. “It’s almost like an ecosystem where the customer shops your retail, the retailers will support the apartments and drive a premium for the apartments.”

The combination of malls and apartments is not a new concept, but more landlords across the country are rethinking their use of space in this way. The strategy builds on the live-work-play communities that are built to accommodate the needs of its residents and have been become popular in the past decade with young adults seeking amenities within walking distance.”

Danbury Fair Mall, CT October 10, 2024

DANBURY — The city Zoning Commission unanimously approved a new zone that would allow the Danbury Fair mall to build 140 or more apartments in the empty former Lord & Taylor store praising the mall for “changing with the times.”

“We don’t want to see any seller or property owner getting into a desperate situation because…they haven’t been able to change with the times,” said Theodore Haddad, the commission chairman, shortly before a Tuesday night vote. “I think this petition is changing with the times.”

Haddad was referring to a master plan by Danbury Fair to stay competitive during a time when big retail is declining by rebranding itself as a “24-hour environment” with apartments, entertainment and other non-retail uses. The first step in the mall’s master plan was accomplished Tuesday night when the commission approved a new zone that will give the mall flexibility to attract non-traditional tenants to its 1.3 million-square-foot space.

Connecticut Post Mall

The Milford Planning and Zoning Board at its Oct. 3,2023 meeting approved changes to the zoning regulations that would allow the mall’s owners to pursue building up to 750 apartments on the property.

Commenting on the owners, Centennial Real Estate, approval, Mayor Richard Smith said, “We need this development as much as they (Centennial) do, if not more, I think our knight in shining armor did gallop in, but it’s not Amazon. This is exciting.”

One difference in the new proposal by Centennial is the designation of 10 percent of the apartments as deed-restricted affordable housing – helping Milford increase the number it needs to meet affordable housing targets.

Whitney Livingston, president of Centennial, said her industry has seen dramatic changes in the last decade. She said that most malls were built as an enclosed space with a few large anchor retailers surrounded by numerous smaller retail operations, largely centered around selling apparel and accessories. But those have been eroded by the fall of department stores, the rise of online shopping and retailer bankruptcies.

“Consumers today are looking at more than just apparel shopping,” Livingston said. “They want experience, which means we as mall owners must deliver entertainment, better food and beverage, health, wellness, beauty, lifestyle service, all alongside apparel and accessories in a very different environment. We must offer a fun, walkable, indoor and outdoor experience that includes amenities like art, music, entertainment and vibrancy.”

Livingston pointed out that the Post Mall has been steadily losing tenants under its current setup. As Milford’s largest single taxpayer, it has paid out about $250,000 less in taxes to the city each year – meaning a larger share of city revenue has to come from other sources, including residential property owners.

Smith echoed Livingston’s point in his remarks. Smith related that he had been meeting recently with credit rating agencies, who he said were pleased when they heard that he would be speaking in favor of the mall development.

“We need to be partnering with the Centennials of the world to put them back online so that we can realize the tax revenue and other residual benefits.”

The plan Centennial proposed would be completed in three phases over approximately 10 years and include outdoor plazas and green spaces. About a third of the residential units would come on board in each phase.

White Plains Mall, New York

The fate of the 50 year old mall in White Plains took a different turn. Unfortunately, this mall lost tenants and eventually became functionally obsolete, changed ownership and was demolished last year.

Plans call for the construction of four multifamily buildings totaling 860 apartments including 78 affordable units. Located two blocks from the Metro-North train station the redevelopment will include dining, retail and other commercial spaces.

“This is going to bring life, it’s going to bring public space, dining and street life,’ Mayor Thomas Roach said. The project is being developed by RXR and the Cappelli Organization.

We continue to watch the ever changing retail world!

Back to Basics: Parking

 Let’s talk about something simple, parking (or maybe it’s not so simple). When someone decides to develop land and put up a commercial building on that site, the first thing they need to do is to read that municipalities zoning code to determine what use will be permitted. Then they need to look at all the other zoning requirements to calculate how big a building can be built. One of the key issues is how many parking spaces will be needed.

 Wouldn’t it be great if all municipalities thought the same way, but they don’t. Here are some examples but check your local zoning. It is common today for Office Buildings to require extensive parking lots, as many of the employees stay in the building all day long. Many areas describe the requirement as a ratio 5:1, meaning that five parking spaces are required for every 1,000 square feet of building.

 Retail buildings will have parking spaces turnover as people park, shop and leave with someone else then using that space. Retail may use a 3:1 ratio, three spaces for every 1,000 square feet. However, unique uses like a showroom or appliance stores would probably have less traffic, thus requiring fewer spaces. Restaurants on the other hand may require more parking. Sometimes the zoning code description seems a bit odd, “One parking stall for each table plus one for each employee” A table being considered having four seats. If a small restaurant had 10 tables, seating 40 people, and six employees they would need 16 parking spaces.

 Industrial Building, warehouses, manufacturing facilities, are often very large but most of their space is for storage or production, with a smaller number of workers in that building, requiring less onsite parking.

 The goal of the zoning requirement is to be sure whatever type of building is being erected, it will have sufficient onsite parking for all the workers and/or visitors in the building.

 Once we determine from the code the potential size of the building and the number of required parking spaces, the land needs to be evaluated. Is it level, a square, rectangle or oddly shaped, any areas unusable, water issues, hills, boulders, trees that need to be removed. A layout of the site needs to be created. To do this we need more information.

 As a rule of thumb, parking spaces need to be accessed using an “aisle” or “driveway”. Assume the code requires a 20’ x 10’ stall for a regular size parking space, we would need a 20’ aisle to access it. Most lots are designed with two rows of parking and an access aisle between them. When creating a parking area “curb cuts” from the main access roads must be included.

 Just to complicate things a little, when building larger office buildings, they may want additional “visitor” parking spaces and many tenants may want assigned parking spaces for their executives, all near the building entrances.

 For each type of building, we also have to determine the number of “handicap” spaces required (which are generally the equivalent of 1 ½ regular spaces in width). Large parking lots may allow a certain number of “compact” spaces for smaller cars.

 A developer is hoping to put up a one story, 9,000 square foot (SF) office building and the parking ratio is 5:1, requiring 45 parking spaces. However, the property layout will only yield 40 spaces, now what? Perhaps a two story, 4,500 SF per floor building would yield the extra parking space needed (provided the codes height regulations allows two stories). Or, with only 40 parking spaces they may have to reduce the size of the building to 8,000 SF.

A Variance (exception to the rules) may be granted by the local Zoning Board to allow the 9,000 SF building with only 40 onsite parking spaces based upon adjacent street parking spaces. Or the Town could have a public Parking Garage in proximity to the site.

 Or, how about the developer building a parking garage or underground parking on the site. The problem with this is its cost prohibitive for a small building, costs for these structures are in the range of $10,000 per parking stall.

 A word of caution about Variances, they could be temporary. You’re hired to lease a store in a five-store strip center. It was previously used as a restaurant, so your immediate thought is to find another restaurant as the tenant. The original restaurant had signed a ten-year lease, which is now up, and they are moving to a larger site. But at that time, they did not have sufficient parking for that use and a Variance was granted.

 This must be looked at very carefully, in some cases the variance will end on abandonment or when that lease expires. Other Zoning Boards may give a short window to replace the current use: the variance will continue if you lease to another restaurant within six months. If not, the use reverts back to retail, and another variance for restaurant use would have to be applied for.

 Rule to Remember: when listing commercial buildings always check the zoning and details of any existing variances.

Back to School

 I went to my local office supply store yesterday; I forgot this is the last week of August and for most kids school starts next week. The store was mobbed with parents and children buying notebooks, binders, pens, and other school supplies. I was reminded how hi-tech education has gotten when I saw the display of flash drives sold out.

 When was the last time you went back to real estate school because you wanted to, not because you had to take continuing education? Has our industry changed – you bet!

 Now we have smart phones with hundreds of apps that can help us get where we want to go, display listings and just about do anything else. I Phone’s that we can do a presentation on; the HP10BII+ calculator designed to do our real estate math. Have you learned how to use all these “tools”.

 Did you know that almost half of our work force today is from the millennial generation? Did you know that we now have six different generation categories? All with different characteristics, different information gathering techniques and buying habits. Do you know the best way to communicate with each age group?

 How well can you read body language? Would it help your business to take a course in negotiating skills?

 As a commercial agent what is your level of “Green” knowledge. Are you familiar with the concepts of energy efficiency, the rating requirements for LEED, what buildings in your market are Green? Are you ready for the customer who says they want to lease space in a Green building? Have you experienced your first green lease yet?

 When it comes to education, there are many resources to help make you a more knowledgeable professional. You can take technical courses on commercial real estate at many local Realtor Boards, and the CCIM (CCIM.com) and SIOR (SIOR.com) institutes offer excellent courses. Other training programs are available from “Top Dogs” Commercial Real Estate Training (tdogs.com) and the Mike Lipsey School (lipseyco.com).

 Today courses are mostly offered through Zoom meetings, or online, by webinar or videos. Using the internet you can find resources and courses on almost any topic.

 Maybe it’s a good time for you to go back to school and learn more about investment property analysis, lease verses buy, 1031 Exchanges, today’s financing or just how to use today’s “tools”. Consider improving your skills, take a course on understanding today’s generations, creating better listing presentations, body language, or negotiations.

 Education is a good investment of your time, so go back to school!

1031 Tax Deferred Exchanges Part 2

The sale of real estate held for more than 12 months triggers Capital Gains taxes on the Net Profits of that sale. These taxes may be deferred by participating in a 1031 Tax Exchange, in essence, by purchasing property(s) to replace the one(s) being sold. However, there are stringent rules and timetables that must be complied with. This applies to the sale of commercial or investment property, but not your personal residence.

The entity that conducts the 1031 Exchange is known as a Qualified Intermediary (QI). The IRS requires that a “third party” conducts the exchange, so the QI will act as a principal in the transaction. How it basically works: the taxpayer will relinquish property title (of the property being sold) to the Intermediary, who will actually sell the property and hold the sale proceeds. Then the QI will act as the buyer of the replacement property being purchased. The QI prepares all the required documentation, provides complete accounting to the taxpayer, and concludes by transferring the title of the new acquired property to the taxpayer.

There are many types of exchanges, in this article we will only discuss the fundamentals. If your client is interested in a 1031 Exchange they should consult a Qualified Intermediary before listing their property for sell.

A few important rules about these transactions:

 1031 Exchanges can only be don’t in the contiguous 48 States, they may sell property in one State and buy property in another.

Qualified Intermediaries (QI): Currently there are no licensing requirements. Clients should request how their monies with be safeguarded, is the QI insured, bonded etc.?

The QI cannot be the taxpayer. Or the taxpayer’s accountant, attorney, or real estate agent, who worked with the taxpayer during the prior two years, they are disqualified from serving as the QI.

Qualified Properties

n       Replacement property acquired in an Exchange must be like kind to the property being relinquished (sold).

n        Like kind means “similar in nature or character, notwithstanding differences in grade or quality.” Both the relinquished and the replacement properties must be held by the Exchanger for investment purposes or for “productive use in their trade or business”.

Over the years this definition has gotten broader now you can mix and match any investment property, for example:  selling an office building and buying a retail center, selling a retail center and buying a multi family or selling industrial property and buying an office building.

n        Personal Property is not eligible for exchange.

General Rules

n        The transaction begins on the date the title to the relinquished property (being sold) is transferred to the Qualified Intermediary.

n         The taxpayer must identify the replacement property(s) (being acquired) within a 45 day acquisition period, following the transfer of the relinquished property.

n       Title to the replacement property must be received within 180

Calendar days after the transfer of the relinquished property.

n        All proceeds of the sale of the relinquished property must be held by a third party, a “Qualified Intermediary”.

n        All cash proceeds must be invested to have a fully deferred taxable gain.

Three Acquisition Rules

n       The Three-Investment Property Rule states that the exchanger must identify up to, but no more than three potential investment properties during the acquisition period.

n       The Two Hundred Percent Rule - This rule dictates that, in the event that three or more like kind investment properties are selected as replacement investment properties, the aggregate market value of said investment properties being purchased may not exceed 200% of the market value of relinquished investment property.

n       The Ninety-five Percent Exception. In the event that rules 1 and 2 do not apply, the Ninety-Five Percent Exception takes precedence. This rule dictates that the aggregate market value of all replacement investment properties must represent        at least 95% of the value of the relinquished investment properties in order for the exchange to still qualify.

Full and Partial Exchanges

When all the proceeds of the sale are used to purchase a replacement property and the value, equity and debt are all “equal to or greater than” a full deferral of the Capital Gains Tax is possible. If all these rules are not complied with, a partial deferral of the taxes may be possible.

n        “Boot” – A term used to describe other non-qualified property received in an exchange, that is not like kind to the property acquired. (cash, stock, personal property)

n        The “boot” proceeds in the exchange are considered a gain and are taxable.

n        For a full deferral of capital gains taxes, the value, equity and debt must be “equal to or greater than”.

Examples:

Full Deferral of Capital Gains Tax – each category is “equal to or greater than”.

                                  Relinquished                 Replacement
                                  Sold Property                Purchased Property
Value                         $450,000                      $600,000
Equity                        $200,000                      $200,000
Debt                          $250,000                      $400,000

 Partial Deferral of Capital Gains Tax

In this case the taxpayer is taking $50,000 cash from the equity they have in the building they are selling. The “equity” is not equal to or greater then, consequently this “Cash Boot” will be subject to the Capital Gains Taxes.

                                    Relinquished                 Replacement
                                    Sold Property                Purchased Property
Value                           $450,000                       $600,000
Equity                          $200,000                       $150,000
Debt                             $250,000                       $450,000

Partial Deferral of Capital Gains Tax

In this case the taxpayer is buying a property for less money than the property they are selling,  their “value and debt” will no longer be equal to or greater than. The IRS considers mortgage reduction a taxable event. Consequently, the taxpayers “Mortgage Boot” of $100,000 will be subject to Capital Gains Taxes.

                                     Relinquished                 Replacement
                                    Sold Property                Purchased Property
Value                           $450,000                       $350,000
Equity                          $200,000                       $200,000
Debt                             $250,000                       $150,000

As one can see 1031 Tax Deferred Exchanges can be very beneficial but they are complicated with many rules (only some of which we have examined in this article). There are many different types of exchanges and clients need to speak with a specialist, a Qualified Intermediary.

The most important aspect of 1031 Exchanges is the timeline. All parts of the transaction must be completed in 180 calendar days. Problems can occur, what if the selected property to purchase is found to have pollution problems during the due diligence period or the income and expenses represented by the seller are not true. One could run out of time!

There is a possibility of doing a 1031 Exchange by acquiring a share of a property through Tenants-in-Common or Delaware Statuary Trust structures, which can usually be closed in a matter of weeks.

The first benefit of 1031 Exchanges is to defer the Capital Gains Taxes when selling investment property to the property being purchased.

Many investors do 1031 Exchanges every few years, each time buying a more expensive property, with the money saved by not having to pay the capital gains taxes at that time, thus increasing their cash flow and wealth.

The greatest benefit is to their Heirs. When the taxpayer dies the property goes to their heirs on a “Stepped-Up Basis”. All the built-up capital gain disappears. The current market value of the property at that time passes to their estate, if the property is then sold there would be no appreciation or depreciation and no capital gains taxes due.

1031 Exchanges – Part 1

We will begin this article by looking at the history of 1031 Exchanges, next month we will illustrate the procedure and rules. Congress, in an effort to pay for the American Civil War, imposed the first income tax in 1861. The Revenue Act of 1861 collected a tax of 3% of all incomes over $800 a year. As time went on, issues of tax policies, rates and “fairness” plus how to stimulate the economy were continually discussed in Congress.

When someone sold a property how could they be incentivized to buy another property rather than hoard the money (that was left after paying taxes on the sale)? After all, if the money from the sale were reinvested into a replacement property there was no economic gain or cash to pay the taxes.  Thus in the Revenue Act of 1921 the first tax deferred like kind exchange was authorized. In 1928 this was formally titled Section 112(b)(1) of the tax code.

In 1935 the concept of using a Qualified Intermediary (Accommodator) to conduct the exchange was added. The Federal Tax Code was amended in 1954 to change the section number from 112(b)(1) to Section 1031. Prior to 1979 exchanges were accomplished in a one day long closing; the relinquished property being sold followed by the replacement property being purchased.

T.J. Starker and his son sold timberland to Crown Zellerback, Inc. in exchange for a contract to acquire certain properties within 5 years. The IRS disallowed this “delayed” exchange. In 1979 the Starker Family sued the IRS and won the case setting precedent for today’s non-simultaneous, delayed tax deferred exchanges. In 1984 Congress adopted the 45 calendar day identification Period and the 180 calendar day Exchange Period; imposing a limit on the length of the exchange opportunity.

The Tax Reform Act of 1986 restricted tax benefits of owning real estate and really catapulted 1031 exchanges into the forefront. The act eliminated preferred capital gains treatment, taxing them as ordinary income; eliminated accelerated depreciation in favor of straight line over 27.5 years for residential property and 39 years for commercial property.

In 1990 the IRS issued comprehensive Tax-Deferred Exchange Regulations which for the most part are today’s guidelines.

Two additional advances have occurred since, in 2002 fractional or co-ownership of real estate known as Tenant-In-Common ownership was authorized to be used in an exchange. In 2004 Delaware Statutory Trusts were ruled as being real estate and therefore as a replacement property solution for 1031 exchanges.

The first benefit of 1031 Exchanges is to defer the Capital Gains Taxes when selling investment property to the property being purchased. Many investors do 1031 Exchanges every few years, each time buying a more expensive property, with the money saved by not having to pay the capital gains taxes at that time, thus increasing their cash flow and wealth.

The greatest benefit is to their Heirs. When the taxpayer dies the property goes to their heirs on a “Stepped-Up Basis”. All the built-up capital gain disappears. The current market value of the property at that  time passes to your estate, if the property is then sold there would be no appreciation or depreciation and no capital gains taxes due.

Negotiating Personal Guarantees

Periodically, like after the recession of 2008 when property values crashed, it becomes common for Landlords to require Personal Guarantees from their Tenants. As the economy recovered toward the end of that decade values had been increasing again and landlords stopped requiring personal guarantees. There thinking was, if the tenant vacated the space there were ten other tenants who would want it and pay higher rent for it! Then the pandemic changed everything. Now in this post-pandemic era of business uncertainty landlords are again seeking Personal Guarantees from their Tenants.

With a Personal Guarantee, if the Tenant defaults on their lease obligation, even if the Company files for bankruptcy, the owner(s) of the business can be personally responsible for the outstanding rent, for the remainder of the lease term. Meaning their personal property is at risk: their home, bank accounts, investments, wages, etc. The amount of the obligation can be significant. In a 5 year lease, if the rent is $25,000 a year (without escalations), the Personal Guarantee required of the owner(s) is over $125,000! In a 10 year lease, if the rent is $50,000 a year (without escalations), the Personal Guarantee required of the owner(s) is over $500,000!

There is no doubt when it comes to Personal Guarantees in a lease the Tenant needs legal representation. The language of a guarantee can be very complex and must cover a variety of issues. In a corporation, all four of the corporate officers may be responsible for Personal Guarantees of the lease. What is the amount each is responsible for, 25% of the liability? Probably not! What does the language of the Personal Guarantee say?

Most boilerplate lease guarantees impose, “joint and several liability” on the Tenants and the Guarantors. This means that the Landlord has the right to collect all of its damages from any one of the Guarantors. The Guarantor who gets stuck with the bill has the burden of seeking contributions from their fellow Guarantors.

There are many “what if’s”, that need to be addressed, In a corporation or partnership, what if one of the officers or partners retires, leaves the business or are bought out by the others? Is there lease liability released? Assumed by the others? Does the Tenant have the right to substitute for another Guarantor at any time? What happens if the building is sold?

Tenant Improvements. Landlords are concerned in recovering the cost of Tenant Improvements (TI) or the cost of removing the improvements in the event the Tenant fails. When a Landlord agrees to do construction or Tenant Improvements they generally amortize the cost over the term of the lease; adding the costs to the base rent. If the Tenant defaults some of this money would not be recovered. This can be addressed with a Personal Guarantee for the construction cost. The amount of the Guarantee should be reduced down with each year that the Tenant fulfills their lease obligations.

When representing a Tenant the Real Estate Agent needs to negotiate alternatives that minimize the liability for their clients.

What is the Landlord really trying to do in imposing a Personal Guarantee? Vacancy is the “kiss of death” for Landlords, it interrupts their cash flow, may hamper their ability to pay their mortgages, or refinance their building. It may take a considerable time to replace a Tenant. So as a starting point one needs to assess the local marketplace and determine in the event the Tenant vacates how long will it take to find a new Tenant and have them start paying rent. With that information the Landlord can be approached with alternatives to the Personal Guarantee.

Increase the security deposit to reflect the anticipated “down time” not collecting rent. This could be 6 or 12 months. Most States regulate residential security deposit amounts, but not security deposits for commercial properties. This money is coming from the business funds not the owner’s personal monies.

An established business with good financial resources may be able to get a Letter of Credit from their bank to guarantee the lease. This is based on the resources of the business with no additional liability to the business owner(s).

Establish a time limit. Most new businesses, if they fail, do so within the first two years of business. Agree to a personal guarantee but limit it to two years. Perhaps offering the Landlord to review the company’s sales after two years and if the business has increased in sales, remove the guarantee.

Landlords want to see a record of payments that establish credibility. It is a five year lease; ask the Landlord, if we make all our rent payments on time for three years will you remove the guarantee?

Cap the Guarantee. Agree that if the Tenant terminates the lease the Landlord should be able to find a replacement tenant within 6 months. Tenant agrees to pay rent for up to 6 months after lease termination (or until another tenant commences rent payments, which ever period is shorter). This is sometimes referred to as a Liquidated Damages Clause; Tenant agrees to a preset and mutually agreed amount of money to settle any default.

Loss Mitigation. Whenever a Personal Guarantee is required, a Tenant should insist on a Loss Mitigation Clause in the lease. Generally, before a Landlord can go after the Guarantor they must “mitigate” their loss by taking and using all security deposit, actually marketing the space and only after a replacement Tenant is found; determine the amount of loss. The Landlord may include in determining the total loss: the number of months not receiving rent, marketing costs, legal costs, renovation expense and real estate commissions. This process may be regulated by local laws.

Back to Basics Retail Properties

Stores may be free standing, found in strip centers, shopping centers or malls. Retailers differ in their preference but have a common concern about finding the right location for their business.

A strip center is a single building that has been divided typically into 5 to 10 stores. The structure allows for reconfiguration of the individual store sizes. Stores are either inline next to each other with common demising (dividing) walls., consequently their signage is limited to their front window and door. Or they are end caps, stores located at each end of the center that have the advantage of sign exposure on two or three sides of the store and the possibility of drive through service.

Adding an anchor tenant with the small stores creates a shopping center. Anchor stores are large in size (often a supermarket or department store) and do their own advertising drawing customers to their store and the other shops in the center. Historically anchor tenants pay less in rent and the smaller stores “gladly” pay higher rent to benefit from the anchor stores advertising.

Retail stores are measured by square footage. Measurements taken from the outside walls wherever possible including the thickness of the exterior walls. When stores are adjacent to another store they include half of the thickness of the demising wall(s) in calculating their total square footage.

 Moving up in size, a number of anchor stores, also known as big box retailers, may be clustered on a site without small stores; this is known as a power center. When we have several anchor stores and a large number of specialty shops we call this a regional shopping center or mall.

Retail pricing begins with a base rent per square foot and often passes through additional rent costs to the tenant. Commonly included are their proportionate share of real estate taxes, utility costs and common-area-maintenance. In other cases, when there is a single tenant in the building, there may be a Triple Net Lease (NNN) structure, whereby the tenant pays all the operating expenses of the property.

Commercial practitioners can lease any of these stores or sell the properties as investments. Buyers and tenants will be interested in the tenant mix. What are the businesses of the other stores in the center and surrounding area?  Hint: when you list a store for lease, analyze the tenant mix to determine what type of business is missing from the area.

Demographics provide statistical data usually in rings, 1-3-5 mile or 5-10-20 mile radiuses from the site. Population, median household income, number of single family homes (rooftops), number of apartment units and age breakdowns within the ring are used by retailers to determine if their business would be successful at that location. Traffic counts, the number of cars that pass the site each day and in cities pedestrian counts can also influence site selection decisions.

Unique only to retail are Percentage Leases. These can be structured in various ways.  In addition to the base and additional rent, a percentage of all retail sales is required, common in the larger malls. Sometimes, the tenants base rent may be reduced and a percentage of sales is added. For example, an Anchor tenant’s fixed rent may be $3.00 below market value but they also pay 2% of their retail sales. Or in lieu of rent, the tenant just pays a percentage of all sales.

Many retailers look at their business by the calendar year, considering they buy all their inventory at the beginning of the year and make their profit at the end of the year; actually, starting to make a profit in May, June or July of each year. In addition to their base rent they will have to pay a percentage of sales when they reach a defined cap (start making a profit), for the remainder of that calendar year Then the cycle starts all over again the following year. This is called a Natural Breakeven Point.

In this case the percentage of sales is negotiated then applied to a formula: Annual Sales divided by this Percentage equals the Dollar Amount of the Cap (the amount of sales that must be reached for the additional rent to be due).

When listing properties find out everything your customers will want to know.

The pandemic was a huge challenge for retailers and changed how many are doing business today. Smaller stores, less inventory, curb side pickup, online sales and delivery, more social media advertising are all parts of the “new” retail models. Malls are becoming more mixed-use offering combinations of shopping, living, entertainment and dining.

The consumers are changing too, the high inflation and interest rates have people buying less products. The concepts of recycling and reuse are having some retailers adding pre-owned items to their product lines.

In most areas, the present economic uncertainty has retail rents declining and lease lengths being shorter. Unfortunately, this will probably continue well into 2023.

On a positive note, the traditional “churning” by national chains is back. That is a review by national retailers of their various stores sales activity. Those locations that are not being productive may be closed. But, at the same time many of the “national” retailers are also looking for and opening new locations to replace the ones closed.

Some local business may be struggling and in some areas the vacancy rates in retail are up, but empty stores create lease opportunities for agents and brokers. Don’t let the market “talk” affect you, get out there and make deals happen!

Back to Basics – Office Buildings

Users or investors may purchase office buildings. Or tenants may lease part or all of a building. In all cases customers want to know the overall size and type of building. Most office buildings are classified as A, B or C, others are designed specifically for medical use.

Class “A” properties represent “the best available space”, they are the newest, fanciest buildings featuring many amenities, the latest technology, and are built in the most desirable locations. Class “B” buildings can be thought of as a “tired class A”. At one time it was a class A, “the” building to be in, but then someone built a newer, more modern building. Both classes of building appeal to major companies looking to project an image of success to the customers that come to their offices.

Class “C” buildings may be recently constructed, designed to be highly functional, minimizing common areas and maximizing rentable square footage. Class “C” could also be older building that may be reaching structural obsolescence. Perhaps built 70-80 years ago, possibly without elevators or central air conditioning and typically found in “downtown” locations. Tenants for class “C” properties are mostly concerned with keeping their rent expense as low as possible. Usually, their customers do not come to their offices; consequently they are not concerned with a buildings appearance.

Medical space will typically consist of many small “examining” rooms with each having a sink. Most will also have an area to take x-rays, which would require lead in those walls. This unique construction is very expensive, so once a building is designed for medical use it will stay that way. Renting or buying medical space is consequently higher priced than traditional office space.

Many office buildings are large with multiple tenants. Landlords desire to be paid for “every square inch” of their building. In these properties tenants get to exclusively occupy and use a certain amount of space but they also share “common areas” with all the other tenants in the building. So a tenant ends up occupying Net or Usable Square Footage but paying for this space plus their proportionate share of the common area, known as the Rentable or Gross or Billable Square Footage. Different terms are used in different areas and by various landlords. The important concept is that tenants often have to pay for more space than they occupy.

How is office space measured? The general authority on space measurement is BOMA, the Building Owners and Managers Association. Generally, a building is looked at in three ways, certain parts of the building are considered “structural” and would be included in the base rental charge. For example: Thickness of exterior walls, exterior balconies, mechanical penthouse, upper stories of atriums, and major vertical penetrations (staircases and elevators).

The tenants occupied unit square footage is measured from the inside of the walls within their unit and includes all usable space and storage areas. If there are demising walls, internal walls dividing the space, like a private office, that space is included. Tenants must absorb HVAC convectors, columns and interior building projections in their measurements.

The common areas of a building may consist of lobbies and atriums (at floor level), public corridors (and include the thickness of the corridor walls), public restrooms, janitor, electric and phone closets, mechanical rooms, and loading docks. Such measurements will include the “common areas” on all floors.

When a building is first constructed an architect or engineer will measure all the space in the building and determine the overall amount of usable square footage and the amount of common area square footage. The percentage difference between the Usable and Rentable space is known as the Loss Factor or Core Factor. For Example: a building is 100,000 SF in total space, 15,000 SF of that space is common area. The Loss or Core factor would be 15%.

Technical and communication services are a concern of every business. What systems are in the building for phone and Internet access? Agents must determine what hours the building is open, some tenants require access 24 hours a day 7 days a week. Not every landlord however allows this, or they may provide such access only for additional cost. What are the arrangements for employee and visitor parking? If a building has amenities, i.e. health club, child care facility, cafeteria, restaurants, etc. they should be noted when the property is listed.

In addition to the physical appearance, qualities of the building and pricing, investors will need a financial analysis. Space for lease requires the costs and lease terms. What is the rent and what does it include? Some landlords charge additional rent for utilities, common area maintenance, taxes and other items; tenants may also be billed for their proportionate share of common areas in a building. Lease length must also be defined. When does the lease begin and end, may the term be extended? Will the rent be increased in future years; will the escalation be a fixed percentage or based on a Cost-of-Living index? Does the space being leased require any improvements; build outs, who will pay for them?  

When listing office properties, you need to find out everything your customers will want to know.

Since the pandemic the current concern is how much of the building is vacant? This being compounded with “distancing” workstations and the work-at-home issues.

A recent study has listed the 10 cities in the country with the emptiest office buildings. They include Atlanta 14.1% vacancy, Los Angeles 14.4%, Denver 14.6%, phoenix 15%, Chicago 15.1%, Washington D.C. 15.5%, San Francisco 16.4%, Dallas-Fort Worth 17.2%, Houston 18.8% and San Rafael, CA 19.3%.

The reason for the high vacancy rates varies. Some markets, like Chicago and Denver, have high vacancy rates due to excess supply from new construction. Other markets have a retraction in office demand after a pullback in the major industry segment in that market, like Houston with energy and Washington, D.C. with the federal government. Other markets, like San Francisco and New York, may potentially see more impact from remote working than others, because of their higher cost of office rent, cost of living and cost of commuting. 

A concern is, if occupancy rates remain low, the consequential reduction in cash flow, may lead to owners defaulting on their loans.  As the current high interest rates make re-financing, no longer an option. Overall, the values in many of our office buildings has been reduced.

A spokesperson for Moody’s Analytics CRE has forecast that they expect occupancy rates to start improving by 2025. In some regions like the “Sun Belt” States they have already seen some occupancy improvement, largely due to less new office space construction and less work-at-home employers.

Another solution with some of these buildings is to repurpose them. We have seen a trend in 2022 to convert some office buildings to residential use, especially in cities that have rebounded strongly from the pandemic, such as New York City and Miami.

The “experts” seem divided with the question; is now a good time to buy office buildings? On the positive side the prices are down but the interest rates continue to rise. Will the current cash flow require a larger down payment? Another concern is many leases were started before the pandemic. When these leases end will the companies want to renew, but for less space or look to move to smaller units elsewhere. Historically we can look at real estate cycles, which tend to repeat themselves, and anticipate a turnaround within the next five years. With this asset class stabilizing and starting to grow again. Right??

Back to Basics - Industrial Buildings

Industrial properties traditionally consisted of three major groups: warehouses (used for storage, production, and manufacturing), Research and Development (R&D) and distribution.

Warehouses may hold goods for a long period of time. The ability to store or stack goods changes the focus with most industrial buildings from square footage to cubic space; ceiling height being a significant measurement.  Under steel (US), i.e. 24’ US, twenty-four feet under steel is the measurement from the floor to the bottom of the steel girders that support the roof. Goods may not be stacked higher than the bottom of the roof supports. The distance, span, between the columns that hold up the roof is important to many businesses especially if they store trucks or vehicles in the building.

Access to these buildings may be by overhead doors (like a garage door at a home, but large enough for a tractor trailer truck to enter). Loading docks are platforms of a height that match the bed of a truck allowing goods to be rolled off the truck. Tailboards allow a truck to back up to a building entrance (usually the size of the rear of a truck bay) and roll goods off the truck. Sometimes a declining ramp is constructed below grade to allow this function. Listings should indicate how many of each type of loading facility the building has.

Generally, warehouses contain 10% office space. Their size is described by their square footage, which is measured from the outside of the building including the thickness of the exterior walls.

A factory or manufacturing plant is an industrial site, usually consisting of buildings and machinery, or more commonly a complex having several buildings, where workers produce, manufacture, or assemble goods or operate machines processing one product into another.

We find R&D buildings are generally half laboratory for research and development of new products and the balance of the building is used for storage.

Distribution centers may hold goods for a short period of time, often having access from two sides of the building. Visualize a food distribution center having trucks delivering full loads of one type of product, meats, dairy or produce on one side and other trucks on the other side picking up portions of all the products for delivery to grocery stores.

The advent of e-commerce has developed another type of distribution building that offers bulk storage and acts as a “last mile fulfillment center” with small trucks making local deliveries. Amazon has 110 Fulfillment centers in the U.S. ranging in size for 600,000 SF to 1,000,000 SF

In recent years another term has been added to descriptions of industrial buildings in some areas, flex buildings. It is actually not a building but rather a type of zoning. Over the years products have gotten smaller and overnight delivery of most products is now possible. Consequently, demand for some of the warehouses in the 75,000 – 100,000 SF range has been reduced. With no tenants or buyers interested in these buildings, the owner cannot afford to pay their mortgage and the real estate taxes are not getting paid as well. The local municipality needs their real estate tax revenue so they rezone the property from industrial to flex zoning allowing multiple uses in the building. Now the building may be used in part for offices, part retail showroom, some self-storage or even apartments, restoring the tax revenue.

Key concerns of industrial “users” also includes amperage (power in the building), sprinklers, floor load (literally how much weight can a floor support, especially important in multi-story buildings), and available technology access. The current occupant may not use computers, butyour customer may be very hi-tech. If the building is not currently“wired” find out what phone and internet access services are available – your customers will want to know.

Industrial companies may be somewhat flexible as to the location of their facility, but need to consider access to major highways, transportation expenses, labor availability and labor costs. Employees may require access to mass transit.

Sale listings for industrial buildings typically quote the price per square foot as buyers compare this cost with other buildings and new construction. Often an industrial owner will list properties for either sale or lease (make sure your listing agreement covers both contingencies).

During the pandemic to today the demand for industrial buildings has increased dramatically. The 3^rd quarter of 2022 demand was up 13.5% over 2022. Vacancy averaged only 4% in 2022. Low inventory and higher demand created higher rents and sales prices. In addition to the traditional uses we are finding many retail businesses seeking industrial storage space for their overstocked merchandise.

A problem that does exist is that 70% of industrial buildings were built before the 21^st Century and 1/3^rd of these buildings are over 50 years old. New construction was halted or delayed during the heart of the pandemic due to building materials and labor shortages. However now there is over 500 million square feet in construction, expected to be completed in 2023, which will start to keep up with demand.

These new buildings will be more people and environment friendly featuring high leverage ventilation systems and other green policies and procedures. Warehouses will feature high tech production and automation. Delivery vehicles are going electric. All to provide a healthier work environment and help reduce carbon emissions.

Many companies are re-evaluating their supply chains and we are seeing a trend back to onshore manufacturing, USA production.

Tenanted industrial buildings may also be sold as investments. These investments tend to have less turnover and longer leases. Many are Triple Net (NNN) leases with the tenants responsible for maintenance, real estate taxes and all other expenses. They are effectively renting “empty boxes” with no need for expensive buildouts and rarely need renovations.

Investor concerns today include the high cost of capital, a slowdown in rent growth and tenant performance. Tenants are concerned with the economy and their businesses performance. Consequently, they seek flexibility in their leases, ability to sub-lease and other escape clauses.

Overall industrial buildings stood the test of time and thrived during the pandemic. I think the key word for today is stabilization. The values (rent and sales) will hold for now but as the new inventory completes construction vacancy will gradually increase and create future price competition.

Back to Basics

Investment Properties

One method by which investment properties are evaluated is known as the Income Approach to valuation. Banks typically use this method when they appraise investment properties. This direct return method of valuation focuses on the cash flow produced. The annual cash flow results from subtracting the owner’s operating expenses from the gross operating income and is referred to as the Net Operating Income or NOI. Buyers use the NOI of a property in developing their purchase offers.

Gross Operating Income has several components. Potential Rental Income (a/k/a Rent Roll) consists of actual and projected income for all rentable spaces. Additional rent charged by the landlord must also be included, such as utility pass throughs, CAM (common area maintenance) charges or real estate taxes.

This income is adjusted for a vacancy contingency, initially in percentage terms, based on the possibility that part or all of the space may be vacant for a certain period of time. In calculating potential lost revenue from vacancy consideration is also given to the number of units in the building, available space in competing properties and overall market conditions. Then this date is converted to dollars and subtracted from the Gross Operating Income.

 Other income to the building, aside from the tenants, is also accounted for, i.e. income from advertising billboards or antennas on the roof. Added into the Performa this creates the Gross Operating Income of the property.

Next is the calculation of the Operating Expenses. This category includes all operating expenses paid by the owner except annual debt service (mortgage expenses). Debt service is not an expense of the building, rather it’s an expense of the owner if they choose to finance their purchase.

Depending on the size of the building Property Management expenses may be included, which are usually calculated as a percentage of the Rent Roll. A contingency fund for Repair and Maintenance expenses (unexpected major problems – not routine maintenance) is also considered as an expense if actually used. How much money should be included in this category is primarily based on the age and condition of the building. Subtracting the Total Operating Expenses from the Gross Operating Income equals the Net Operating Income (NOI).

A CAP Rate (Capitalization Rate) may be practically thought of as a desired profit percentage of an investor. It is based on the concept that a correlation exists between the income a property produces and its market value. Value may be determined using this formula:

Net Operating Income (NOI)   = Market Value

                                               Capitalization Rate (CAP)

For example: If a building had a NOI of $100,000 and the current CAP Rate was 10%, the building would have a value of $1,000,000. ($100,000 ¸ .10% = $1,000,000). Note this is based only on the current year’s performance; some investors project future performance in determining value.

In addition, two other methods of valuation should be considered. The Comparable Method (comps), looking at actual previous sales and what “competition” is currently on the market in the area. The Cost Approach is used with some Industrial buildings and “Green” buildings looking at the construction costs to replicate this building with the same features. These methods of valuation give an agent the ability to answer the question, “What is my property worth?” 

Another way to look at the CAP rate is as the Return on Investment (ROI). If they purchased the property for all cash one can divide the current annual cash flow, the NOI, by the purchase price and determine the percentage return on the investment for the current year. For example: Purchase Price $500,000, current NOI (cash flow) $60,000, Return on Investment 12% ($60,000 ¸ $500,000 = .12%).

However, in most cases when a property is purchased it is leveraged, bought in part using borrowed funds, other people’s money. Most commonly the structure involves a down payment, Initial Investment, paid by the purchaser and a mortgage loan from a bank. The total amount repaid on the loan each year, including principal and interest, is called the Annual Debt Service. If the question is again posed “what return is the investor getting on their investment?” Two formulas are needed to determine the Cash on Cash Return. When properties are financed the Return on Investment is called the Cash on Cash Return.

Net Operating Income (NOI) – Annual Debt Service = Cash Flow Before Taxes (CFBT)

Cash Flow Before Taxes (CFBT) ¸ Initial Investment (II) = Cash on Cash Return (CoC)

The “Taxes” referred to in these formulas are the Income Taxes the owner may have to pay on this building this year.

For example: A property is purchased for $1,000,000 with a 30% down payment (typical in today’s market) $300,000. A mortgage is obtained for $700,000 with a 20-year term and 7.5% interest rate. The annual debt service is calculated to be  $67,670. Assume a NOI (annual cash flow) of $100,000. The Cash on Cash Return is 10.78%.

$100,000 (NOI) – $67,670 (Annual Debt Service) = $32,330 (CFBT)

$32,330 (CFBT) ¸ $300,000 (II) = .1078   Cash on Cash Return of 10.78%

It is important to realize this reflects the current return of the current owner on this investment, or how the property performed financially this year, based on a purchase price and down payment that may have been made several years ago.

A buyer is usually not concerned with the owner’s Cash on Cash return on their investment. The return would only be significant to the buyer if they were assuming the current mortgage – which is rare in commercial transactions.

Usually, the current sales price reflects an appreciation in value that would require a higher down payment. Loan terms and interest rate will also vary. Some owners desire to hold paper or give a purchaser a mortgage themselves to gain the benefit of the interest on the loan and for other tax advantages.

Buyer’s focus on the current and/or future cash flow(s), using the Net Operating Income to determine their purchase offers. 

The real value of the property has a few other steps, Once the Cash Flow Before Taxes has been calculated, the owners Income Taxes for this year, on this property, can be calculated and paid, with the After Tax Cash Flow remaining. By dividing the After Tax Cash Flow by the Initial Investment (down payment) the real Cash on Cash return can be calculated. This will generally increase over time, reflecting the current equity the owner has in this property.

New Year’s Resolutions for Commercial Real Estate Agents

1.     Meet two building owners or tenants in your town every day.

Systematically meet every business owner in your town. Two a day, ten a week, forty prospective clients/customers a month; you will become “The Commercial Agent” in town.

2.     Join and attend Chamber of Commerce meetings and volunteer to serve on committees.

                             Who belongs to the Chamber or Service Clubs? Your future clients; get active in the group to become known.

3.     Call FSBO’s until you get two appointments for tomorrow.

The only reason an owner runs their own ad is because the vacancy is costing them money. Find them a tenant, restore their cash flow and they will be happy to pay you.

4.     Attend Commercial open houses and meet 25 new agents before you eat!

Networking contains the word “work”. At these events work at building up your list of other agent contacts, who may have the buyer or tenant for your next listing.

5.     Catalog everyone you met yesterday (building owners, tenants, agents) into the address groups on your computer.

Multiple address groups; retailers in 1,000 SF – 2,000 SF, office users in 3,000 SF – 4,000 SF, building owners (investors). Blast your new listing to these potential buyers!

6.     Stop by and see two prior clients/customers each week.

Just because they signed a 5 years lease does not mean they will stay there that long. Their business is booming after two years, they need more space. Can you find them more space and sublet the space they are in, and collect two more commissions?

7.     Daily review of all new commercial listings in your area; arrange to co-broke and add to your “comparable” data base.

You need to know every available property in your market area. Your customer asks: “On the way here I passed a building for sale on Main Street, do you know the size and asking price?”

8.     Develop and meet with your  “leads” group once a month.

A” leads” group consists of up to 10 people, but only one person from any industry (one architect, one accountant, one from a moving company, etc.) meeting regularly to exchange information about potential customers

Call MLS commercial expired’ s until you get two appointments for tomorrow.

Expired listings are gold. The owner is frustrated, maybe the agent was not trained in commercial and the property was not marketed properly, time for a change.

10. Join and attend monthly commercial organization’s meetings.

Meet and add other commercial agents to your distribution list; be added to their lists. Great for those new in the business, “pick the brains” of the experienced agents.

These resolutions need to be part of your daily prospecting, which is required for success in our business.

Consider two more resolutions to be the best at what you do.

11. Expand your skills – take educational courses; earn a Certification or Designation.

There is a lot to learn in this ever changing business, stay current and expand your knowledge and services offered.

12. Read business and motivational books.

Knowledge is power. You need to be a “10” every time you make a presentation or meet someone new. Do what it takes to be there.

          Now get out there and make it a great year!

Options

The word “option” is used in several different contexts in commercial real estate.

Option to Extend or Renew

A lease may be written for a specific term and have an option for the tenant to extend the lease term for an additional period, or periods of time (i.e. the term of the lease is five years with a five year options to renew). If the tenant does not exercise the option to extend the lease, the lease ends at the end of the initial term. The rent may be pre-defined for any option period, or determined by a formula, or negotiated at the time each option is exercised. Another method for calculating option rents is a “dual appraisal”. This takes into consideration current market conditions and values. The landlord and the tenant each obtain an appraisal of rental value and use this information to negotiate the future rents.

Option to Expand

A tenant may expect their business to grow and think they may need more space in the future. Rather then move they may look to take more space in the building they are in. At the time they are negotiating their lease they may ask the landlord for an Option to Expand or a First Opportunity Clause. Meaning, if more space becomes available in the building in the future, this tenant will be given the opportunity to rent that additional space, before it is marketed.

Option to Buy

In a lease a tenant may have an “Option to Buy” the property. This is usually for a specific time period and may be for a pre-determined price. If a longer period of time is given to exercise the option to buy a dual appraisal method could be used to determine the sale price at that time.Another form of an option to buy is known as a Right of First Refusal (ROFR). In this case if the owner decides to sell the property, a tenant with a Right of First Refusal would have the opportunity to match a purchase offer from a third party and buy the property. You did not bring the buyer and seller together and would not be entitled to a commission.

 In the case of a Right of First Refusal, your listing agreement must state that if an existing tenant in the building exercises their ROFR and buys the property, as a result of the offer you presented, you are entitled to a full commission. You must also disclose to your customers and other Brokers, if you are co-broking, that someone has a Right of First Refusal to buy the property.

Option to Purchase

When a property is on the market for sale a potential buyer may obtain a Purchase or Sale Option from the owner. Effectively the buyer is purchasing the right to buy the property within a specific period of time. The owner is being compensated for taking the property off the market and not selling it to anyone else during this time period.

For example, a sales option could be used when a property is desired for a use that will require a change of zoning. In some areas the procedure could take a long time. An owner may not want to sell their property “subject to” zoning approval and wait to close. A Purchase Option would compensate the seller for taking the property off the market and give the buyer time to obtain their approvals. The monies paid for the sales option are fully earned by the owner. At the end of the option period the buyer must close on the property or the agreement to purchase ends. Frequently if the buyer goes forward with the purchase the monies paid for the purchase option will be credited towards the sale price.

Brokers must be careful that their listing agreements cover all these possibilities and indicate what commission would be due if any of these options are exercised.

Assumption Agreements

Often a lease will have an option for renewal by the tenant. If the option is exercised the Broker is usually entitled to an additional commission. But what happens if the building is sold before the option becomes due? Is the new owner responsible to pay the Brokers commission? The answer is no unless the listing agreement or lease addresses the issue.

The original listing agreement (contract) is between the original owner and the Broker. Upon sale of the building (title passing) that relationship ends. The Broker has no agreement (contract) with the new owner. The new owner has no obligation to pay a commission to the Broker. This may also apply to a 1031 Exchange or Assignment of a Lease.

Listing agreements should contain a clause to address this contingency. Typically, the clause directs the building owner, if they decide to sell the property, to have the buyer sign an Assumption Agreement (in recordable form). In so doing the new owner accepts the liability for future Broker’s commissions that may become due if a tenant exercises their option to extend the lease.

Without such a clause in your listing agreement an option commission could be lost upon the sale of the building. In a large building many tenants may have an option to extend or renew their leases; different Brokers may be eligible for future commissions. With Assumption Agreements the buyer is taking on the responsibility to pay these future commissions if those options are exercised. The amount of money involved could be significant and require price adjustments in closing the transaction.

From a marketing point of view, this sale should not come as a surprise. Once you place a tenant in a building you should communicate regularly with the tenant and the owner to develop future opportunities.

 Even though a tenant is in a lease, their business could require more or less space before the lease term ends. Consistent communication would allow the Broker to become aware of the problem and solve it. Find and lease larger/smaller quarters while sub-leasing the current space to another tenant.

Constant communication with the landlord can lead to an inside track as to when other tenants may be leaving the building creating available space you can rent. This constant communication with the landlord could also lead you to having the opportunity to sell the building!

Are QR Codes Coming Back?

In 2010 I wrote the following article. Use of QR codes were active then but seemed to fade away a few years later. The Covid-19 pandemic has seen a resurgence in the use of these “quick response” data icons. Medical and testing facilities are making appointments then sending QR codes to confirm. When they arrive at the facility they simply scan in the code for contactless registration.

Vaccinated residents of Massachusetts are now able to get a digital record of their covid-19 vaccine history including a scannable QR code, that can be stored on their smartphone and presented to businesses requiring immunizations for entry.

QR Codes in Commercial Real Estate

QR codes have been around for quite a while, originally created in 1994 and used to track parts in vehicle manufacturing; today they are finding new applications in the marketing of many products. QR Codes are matrix barcodes (two-dimensional codes) that can be read by a QR scanner. Our mobile technology now allows a smart phone or a mobile phone with camera to add a QR scanner program and read the QR code (symbol shown).

A QR Code is simply a bridge to a website that when scanned with a mobile device takes the consumer directly to that website. This QR codes takes you to my website, www.CommercialEd.com.

You will be seeing these codes on commercial signs in the future. Think of the possibilities for commercial real estate. The buyer or tenant is driving around and sees your sign—they immediately want more information. Scanning the QR on your sign takes them to a web site created specifically for that property, or a link to a full presentation of marketing materials for that building, or a video journey through the building. The link could also be to the agent’s personnel web site, a company web site, other listings or just about any URL imaginable.

One of the technical things that need to be considered is whatever web page or site the customer is directed to must be optimized for viewing on a mobile device.  

The application is not just for signs; a QR code can be placed on flyers to immediately bring more information to the consumer about that property or the agent. They can be used as an enhancement on listing presentation materials taking the customer to the agents’ other listings.  Some agents are even putting the QR symbol on their cars!

To work with QR’s you need a program to create your QR link and you will need a QR reader application for your mobile device. Just “Google” or otherwise search the internet on your computer and you will find a number of sites to help create your QR symbols and readers. There are a number of sites that provide this service without charge. I have used www.scanlife.com myself. Many people now know of the barcode system but for the benefit of those who don’t, add some small text indicating a QR reader is required and suggest a site where they can find it.

As mentioned earlier a great application is to have the QR take the customer to a video of the property or the agent introducing themselves and their services. Use a QR on your business card and bring the customer to your promotional video. Now, that’s a powerful business card!

Today many cell phones come with built in QR code readers, no apps required. Now “Dynamic QR” codes are editable and trackable. A free QR code generator from Beaconstac’s even supports multi-lingual QR codes. This QR code when scanned converts to the language the user’s smartphone is set to, displaying the message content in the language the user prefers.

A major advantage for use in real estate is speed. The consumer scans the QR code and instantaneously can view a property brochure or video 24/7.

We see these QR codes more and more. They are being used on CT Lottery tickets, restaurants are using them to order food and even pay the bills. Toco Bell and Berger King have introduced them into their ordering systems. Just received my phone and credit card bills with a QR codes now on the envelopes and last night on the CBS news they posted a QR code on the TV to get more information about a topic!

I teach at Westchester Community Collage who now requires that anyone going onto the campus must be vaccinated. My vaccination ID card has a QR code on the back for verification purposes.

Considering that many of our future real estate consumers are Millennial or iGen aged, and they “live” on their smartphone. It may be time to start integrating QR codes back into our real estate marketing.

Retail Downs and Ups

Retail stores in the US saw 2021 Black Friday traffic decrease by more than 28% compared to the pre-pandemic period, in a report from Sensormatic Solutions. It says American consumers are increasingly turning towards digital channels for shopping for various reasons, all linked to the Covid-19 pandemic. These include shut-down stores, fears of catching the new omicron variant, or supply chain disturbances that result in half-empty shelves and late arrivals. 

Covid-19’s disruption of the supply chain is really being felt this year, Adobe further suggested, finding that out-of-stock messages on retail websites spiked 124% compared to two years ago. It’s mostly appliances, electronics, housekeeping supplies, and home and garden items, that are out of stock.

CVS to close 10% of its stores

Another retail shocker was announced on Nov. 18, 2021, CVS Health Corp. said it would be closing about 300 stores, Reuters first reported. But that's just the first phase. The pharmacy chain has plans to close about 300 stores every year for the next three years, resulting in roughly 900 store closures by the end of 2024. The store closures will begin in the Spring of 2022, according to CNBC.

Brick and Mortar

Diane Wehrle, marketing and insights director at Springboard was a speaker at the December 2021 ICSC national conference in Las Vegas. In an interview with GlobeSt.com she indicated that the closure of retails stores, due to the pandemic, led to an increased retail spending online. However, “the majority of retail spending continues to remain in store,” she explains. “The fact that even a global pandemic has not significantly dented the extent to which consumers shop in stores demonstrates the continuing importance of in-store retailing and reinforces its long-term future.”

“The importance of brick and mortar retailing to shoppers is reinforced by the fact that over half of those consumers who are now working from home have not changed their shopping habits from before Covid (Springboard US Retail Consumer Survey), which demonstrates why a number of pure online retailers are currently investing in brick and mortar stores that will trade alongside their digital offering.”

Overall, she says that while the impact of Covid is likely to be felt for an extended period of time, the basic human desire for person-to-person interaction and sensory stimulus that sit at the heart of in-store shopping will ensure its longevity and ensure that brick and mortar retailing will outlast this global pandemic.

Globe St. also interviewed Hillary Steinberg, senior advisor of MDL Group/CORFAC International, at the ICSC, who echoed similar thoughts.

“We see retail soaring by as much as 13.5% over 2020,” she explains. “People want to get out of their homes and go shopping, they want to see items in person and they want to eat at restaurants while they make their purchases.”

She notes that people are seeing items advertised specifically to their interests on Instagram, Facebook and YouTube, and then are heading to the shopping center for instant shopping gratification. In addition, she says that “New, unique and specialized retailers and restauranteurs are opening with the mindset that they want to own their own store rather than work for someone else.”

"We have some of the best chain restaurants and then some very unique restaurants that you won't find anywhere else, that's kind of what we want to be."

They are also revamping their food court choices of fast-food eateries to provide a variety of food types and price points for everyone.

The 130 store Stamford Town Center Mall in Connecticut is also expanding its “Restaurant Plaza”. Currently occupied by Pieology, Peter Chang and the Capital Grill, they will soon be adding a Brazilian steakhouse Terra Gaucha and the Mexican restaurant Puerto Vallarta. They also continue to provide various fast-food restaurants throughout their mall.

Shopping center owners are preparing for post-pandemic shoppers, focusing on dining choices beyond the food court plus more “pub” type eateries. Some vacant spaces are being filled with entertainment type businesses like bowling alleys, movie theaters and even fitness centers.

To draw consumers back into their shopping centers owners are creating a
 “shopping-recreational experience”.

Post Pandemic Leases

The Covid-19 pandemic has had and continues to have a profound effect on both Landlords and Tenants; it will change lease terms for the future.

Traditionally it was best for tenants to have a relatively long lease, five years or more and/or renewal options. If business was going well remaining in the same location was preferred unless they needed to move due to growth. Landlords too like longer leases as vacancies disrupt their cash flows and cause additional marketing expenses. But currently the trend is for shorter lease terms and multiple renewal options, tenants and new businesses are unsure of the future. When will this pandemic really end or will there be another resurgence? A two-year lease and three one-year options may be requested by tenants also concerned about product and materials availability and sales activity. Landlords will reluctantly go along with the shorter terms rather than have the space vacant.

Tenants are seeking an “exit plan” for any future events that prevent their business from operating as usual. Many leases do not have Sub-lease and Assignment clauses. Tenants need these clauses in their leases which would allow them to sub-lease all or part of their space or assign the lease to another tenant. Tenants, especially in the office category, may be looking to shrink their footprint as a result of a portion of their workforce working from home full or part time. They would want the lease to allow them to “giveback” to the landlord that unused space. Landlords may not want to do that due to concern about finding another tenant. A solution for these situations would be if the tenant would take responsibility for finding a replacement tenant themselves. Thus, giving the tenants exit options and the landlord not having any period of vacancy.

Both landlords and tenants were unprepared for Covid-19 repercussions of government mandated shutting down of businesses. The business closures affected tenant’s ability to pay rent, and landlord’s ability to pay their mortgages. Although many commercial leases have a “force majeure” or “Act of God” clause, allowing tenants to reduce rent payments or terminate leases in extraordinary circumstances. A pandemic was never contemplated, and the word is not included in the typical definitions of what “force majeure” events are, as a matter of fact “pandemic” has yet to be clearly defined. One of the things changing in new leases will be a clearer definition of “force majeure” events including defining government shutdowns.

In the future sales may be tied to what happens when a “force majeure” event is triggered. If a retail store is closed will the rent be totally abated and if so for how long. If the store is then partially opened what is a fair amount of rent to be a paid to the landlord. For example, a restaurant was initially closed, then it was reopened but only for take-out, doing only 25% of their previous sales. This contingency would need to be defined in the lease, what we may see in retail leases is a shift to “percentage leases” during these periods; tenants paying a percentage of their monthly sales as rent.

We will also see more tenants requesting “Co-Tenancy” provisions in their leases. If an anchor tenant or neighboring stores “go dark” (close) as a result of these “Acts of God” events, the tenants rent would automatically be reduced or be abate or allow for lease termination.

Historically Mall developers seek “anchor” Tenants; major retailers who draw people to their stores though their advertisements and merchandise mix. To entice them to open in their location Landlords offered “sweetheart” leases with very low rents; the Tenants do pay their share of the taxes and Common Area Maintenance charges. Smaller size merchants (inline Tenants) seek to open their business near these anchor stores to get the benefit of the customer traffic; and pay high rent to do so. With one or more anchors and 25 -100+ smaller stores you have a regional shopping center with the largest ones, often enclosed, called Malls.

What happens when these anchor stores like Sears, Macy’s, Kmart, JC Penny, Sports Authority, or even the neighboring stores in a small strip center, “go dark”? Without the traffic to the shopping center the sales in the remaining stores plumet. Co-Tenancy clauses are designed to protect tenants when other stores become vacant but seems to have a new application in the post pandemic era.

Co-Tenancy clauses can take many forms, generally they allow the Tenant, when the other stores go dark, to reduce their rent payment to a predetermined amount or convert their rent obligation to a predetermined percentage of their sales. They may also allow the Tenant to terminate their lease if the anchor or other stores are not rented or reopened within a certain time frame. Now the definitions of the Co-Tenancy clauses are seeking to be applicable and triggered if we have another pandemic or government mandated closures.

Another ramification of the pandemic were mammoth delays in processing permits and zoning applications, and getting inspections and appraisals completed. Most of these workers are back to work now processing this backlog. But construction and buildouts are being hampered by a backlog of materials and supplies. We hear of over 100 cargo ships in California harbors that may not be unloaded until 2022!

Leases are often subject to buildouts (alterations or new construction) being delivered in a timely manner or before the tenant can move in. These delivery issues will now have to be addressed in the leases, whoever is doing the work will request as much time as possible, without penalty when delivery delays are out of their control. A tenant doing their own build out may want the ability to push back the lease commencement date for delays in obtaining materials or permits. Landlords with have the same concerns and issues if they are responsible for construction.

The Changing Fast-Food Industry

The pandemic created a surge in business for the fast-food industry. These companies have learned that consumers are looking for safety and more speed at their locations, plus more convenience with off-site ordering and delivery services.

In October 2020 Burger King introduced its new store prototype featuring a second floor suspended kitchen and dining room over six drive-thru lanes for pickup and delivery. Drive-thru guests have their order delivered from the kitchen via a conveyor belt system, providing a touchless experience.

This new design also reduces the building footprint by 60%, making it ideal for urban cities.

In March 2021 McDonalds announced its expansion plans with a focus on digital, delivery and drive-thru. In 2020 they added delivery to 28,000 of their locations with plans to expand that. During 2021, they are going to open 1,300 new stores worldwide, with 500 of the locations in the United States, and will modernize 1,200 existing locations.

McDonalds is significantly shrinking the size of their stores by eliminating indoor dining, thus allowing for additional drive-thru lanes.

Two more giants in the fast-food industry have just announced their plans.

Taco Bells newly designed buildings are called “Taco Bell Defy”, the company says they will “defy norms and define the future.”

These stores will feature four drive-thru lanes, three for mobile delivery  order pick up and one traditional order style drive through lane. The second floor kitchen will deliver the food through a contactless lift system. Mobile customers will scan orders using QR Codes. There will be video and audio communication available with staff.

Wendy’s hamburger chain intends to open1,200 new locations by 2025; 700 in the United States; with 50 open by the end of 2021. However, 30% of these will not be their traditional brick and mortar restaurants, rather, these will be “ghost kitchens” delivery only!
 

As an experiment they have opened eight of these units in Canada; the positive results have them using this as one of their future models. These “pod” like units can be set up in parking lots and can reach desired markets without paying exorbitant rent.  A spokesperson from Wendy’s noted, "…we want to bring Wendy’s to people through the convenience of delivery, and we think these dark kitchens can help us do that."

The Office Market Challenges

There is tremendous speculation within the industry as to what future office space will look like and how it will be used.

Probably the biggest challenge is what will become of the “work-at-home” concept. At the height of the Covid-19 pandemic, Co-Star reported the 62% of American employees were working from home. Some workers liked the flexibility, but other found it difficult especially parents who also had to home school their children at the same time.

Another factor is the commute or lack thereof. The Urban Land Institute did a study which showed an average of 227 hours a year saved by not having to commute. In addition to the time saved, there were cost savings; health and exposer concerns by those who take mass transit and the reduction of vehicular traffic, which was a plus for the environment.

Our younger generations, many living in small or shared apartments or at home with parents are eager to get back to working in the office building environment. According to Emerging Trends in Real Estate the office atmosphere offers more opportunities for collaboration, learning and making business and social connections.

A survey by Deloitte found that 68% of employers plan to implement some type of hybrid workplace model this year. With a consensus leaning to working-at-home two days a week and staff rotation in the office the other days. This also adds to the overall concept of social distancing by reducing the daily number of employees in the space.  

As we start looking at the physical office design the primary concern is indoor air quality, ventilation, and filtration. This cost burden will fall on the building owners, but employers are concerned for the health and safety of their workers. This may mean upgrading HVAC systems, putting higher caliber filters in place, or even building redesigns to include operating windows.

The pandemic put new focus on virtually technology, this will continue to a permanent part of new business models. According to a report by JLL, offices will need more conference rooms or the smaller version “huddle rooms” to provide multiple areas for video conferencing or presentations. They also see more office plans with bench style seating to enhance collaboration, fewer enclosed private offices, open workstations available on an as needed basis, no more assigned desks. Other permanent post -pandemic designs will include hand-sanitizing stations, touchless technology, and other social distancing measures.

A Cushman and Wakefield report points out the key word is workplace flexibility. Companies are still trying to figure out what to do with the remaining uncertainty about the virus and the work-at-home population.

Some companies headquartered in cities are considering hub-and-spoke models by opening satellite offices in the suburbs where their workers live. This would shorten their commute and, in many cases, eliminate concerns for taking mass transit. The number of employees working in these “outposts” would also be reduced aiding future social distancing workplace designs.

Will office vacancies continue to increase? According to Co-Star report as of the Second Quarter 2021, Nationally office vacancy had exceeded 12%, up 2% over the same time in 2020. No one really has all the answers yet; let us hope that this pandemic finally gets controlled.

Another challenge for office employers is a shortage of labor and the increase in “job-hopping”. They are focused on attracting new hires and retaining talented employees. The office designs need to cater what workers want today and offer other building amenities.

Employees want to be energized and connected thru shared meeting spaces and flexible open spaces. They want to be able to engage with others and at the same time feel safe and comfortable in the office environment. Today’s employee, after a year of working at home, needs to retain some of that freedom; to get outside of the “box”. Perhaps a roof top lounge might give them the break they need. Or that flexible work schedule with two days still work-at-home.

Employers have many challenges, and it will take time to sort out what the new normal will be; and it will not be the same for every company. Hence the “job-hopping” is expected to continue for some time.

Back to Basics – Overcoming Objections

Objections are often statement’s not questions. A statement does not require an answer. Agents often over-react to a statement by a buyer or tenant. They may just be thinking out loud or considering qualifying issues. Showing them a building, the buyer may say “not sure this is big enough.” Or “that’s a lot of money for this space”. Neither is a question they will sort it out for themselves. With some work-at-home rotations we can fit here. This location should be worth the price.

With these types of objection’s, it is best to ignore their comments, but not them, acknowledge the comment, “I heard you” but do not respond to the statement. 80% of these objections will be solved by the client and go away. Caution: answering an objection may create a defensive or confrontational reaction.

A true objection is something that is preventing a listing from being signed or a sale/lease from happening. In the later context it is a buying sign; there would be no objection if there was no interest.

Real Objections

There are two common objections we get every time we try to list a property. Price, owners think their property is worth more than market value. Commissions, they think we get paid too much!

Value Objections

When the owner says, “Are you kidding my property is worth $1,000,000,000,000.95!” Is that a perception issue? Is it really priced too high?

This objection to value is overcome by education and facts and should be handled in the listing presentation itself. To prepare you need to update your “comparables” daily. Because there are fewer commercial transactions than residential we need to look to both closed sales and leases and also what is currently on the market (competition) for our “comparables”. Create your own comparable files by checking the commercial listing services for new listings, reading the news and trade papers for news of closings. When you read of done deals call the agent and congratulate them and ask for the final closing prices.

Prepare to justify your suggestion of market value in your listing presentation. Find 3 or 4 similar type properties in your comparables, different size buildings are OK. Divide the building price by the square footage to determine the price per square foot. Show the client the math for each building and what the average sales price per square foot is for your area. Multiply the average price per square foot by the square footage of their building as the basis for your value assessment.

When the owner says, “My building is worth $_________.” Challenge them by saying,” The comparables I just showed you don’t seem to justify your asking price. Perhaps I don’t understand something. Why are our numbers so far apart?

Sometimes owners say, “Another broker told me my building was worth $________.” Answer with, “Why do you think an agent would tell you your building is worth more than these comparables show?”

“Maybe they are trying to get me to give them the listing.” “What’s your opinion of an agent who would inflate your buildings value just to get the listing?”

Priced right sells or leases. Overpriced properties waste your time, and you make no money. Are you prepared to walk away? Do I want you as a client? If the owners asking price is up to 15% or 20% over market, I may take the listing with a “hook”, but any higher over market I walk.

“I am certainly willing to try to sell/lease your building/space at that price. But I want you to agree that you will be willing to reconsider the price if the property/rental unit doesn’t sell/lease in 30 days.”

Better, “Frankly, I have to make a decision if I want to invest my time and resources into marketing your property. Would you consider reducing your price to $_____ if we do not get any activity within the first 30 days at your price?” Then write in your listing agreement, on __date__, listing price is reduced to $_________. Have owner sign so the reduction becomes automatic.

You can use these same techniques for lease, be sure when comparing numbers you have the total cost per foot including base rent and all additional rent pass throughs.

Investment Properties are compared using the Capitalization Rate (CAP Rate) of the properties. A Cap Rate is determined by the formula: Net Operating Income (NOI) divided by the Value (price) equals the CAP Rate which equates to the Return on Investment (ROI), Prepare by finding and determining the CAP/ROI on 3, 4 or more of your investment comparables. Remember as the price goes up the return goes down.

Ask the owner, “If you were buying investment property today what would be the minimum acceptable ROI to you?” They may say, “6.5% - 7%”. Then do the math using the NOI and their asking price to see what return they are offering to a buyer. “At the price you are asking your only offing a 3% return!” Educate – show them the math.

Also explain, ‘A lower return on the invest will require a higher down payment to finance. The higher the down payment required the fewer potential buyers.”

Commission Objections

            Now let’s look at overcoming commission objections. This too should be addressed in your listing presentation. You need to show the client what you can do for them, that they cannot do for themselves, itemize the skills you bring to the transaction. Also create a detailed list of how you are going to market their property or space. Show them examples of marketing pieces and how their property will look on the websites you use.

            It is human nature to try to get a good deal. Often people ask will you to reduce your fee or cut your commission just as a matter of course. Sometimes a simple “no” will suffice. Learn to say no, nicely, “no, any other questions?”

Understand if you agree to lower your commission, what message is being delivered about your negotiation skills. The client may feel you may not fight to get them the price they want, and they may not higher you. Stick to whatever commission rate you asked for, never lower your fee to get the listing.

They ask, “Would you reduce your commission?” Reply with a “chuckle”, “Is this a test to see how I negotiate? I won’t lower my commission and I will get you the price you want for your building.”

Challenge the owner with a question when they ask “Would you reduce your fee?” “How do you react when your customers ask you to reduce your prices (fees)?”

          Commission challenge response, “I’m glad you brought up commissions, I did make a mistake, our company just raised our sales fee to X%. But since I did make a mistake, I will honor your listing agreement at Y% that I quoted you.

Understanding the math, clients have a perception that reducing your commission by 1% or 2% is not a lot of money. Before we look at an example, remember all commission rates are negotiable, the numbers used here are only for illustration. Calculate your commission dollars based upon your commission rate and suggested price, then recalculate based on 1% less and 2% less commission, see how much money you would be losing if you lower your fee. You will find the reduction in percentage terms can be 14% to 35% of your hard earned money.

Say to the client, “I know 1% does not sound like much but do you realize you are really asking me to reduce my fee by ___15%___ ?” Or. “I know 1% does not sound like much, but you are really asking me to reduce my commission by ___$5,000. ___.”

 When they tell you, “The other agent said they would reduce their fee.” Reply, “I can appreciate that… can I tell you why that makes me nervous? If other agents do not have the courage… to stand up to you… regarding their own worth… how strong could they be… defending you… and the price we set on your property…    [name], I have that courage… do you feel I can sell/lease your property?  (yes) Terrific!  All we need to do is…simply… sign this agreement… so I can help you get what you want… in the time you want… won’t that be great?”

Another way to response, is to ignore their statement and respond with, “I am an awesome negotiator. Once I list your property, I will treat it as if it were my own. I will not give away one dollar of your equity… you may choose to, but I won’t.” Understand there may not be another agent, this may be a test of your negotiating skills.

Referring to your commission the client says, “That sure is a lot of money!” Answer, “Do you realize on a typical commercial transaction I only receive a quarter of the commission. There may be another agent involved, my broker gets half, and then I still have to deduct my expenses and pay taxes.  Taxes! Out of that I pay 24% income tax plus 15.3% self-employment tax and good old State tax. I’m sorry, but I just realized I have to increase my commission fee.”

“Your commission is too high.” “You want to receive the maximum dollars possible for your building. I am known as a tough negotiator and I will negotiate a top dollar deal for you, but I don’t negotiate my commission.”

There is a time and place to use some of these replies but what will really convince the client to pay you your worth is in your listing presentation. Given an objection to your fee, you may want to review your marketing plan and the skills you bring to the transaction again with the client.

Back to Basics:

Developing Your Commercial Referral Business

Want to increase your opportunities for commissions, build your referral business?

A consistent program is the key to success. Begin with a “sphere of influence” list, literally everyone you know. Prepare a brief letter announcing or reminding people on the list that you are in the commercial and investment real estate brokerage business. Add a few comments about your company and then ask for a referral. “Is there anyone you know whom I might be able to help?” You know these people, so end your letter with a handwritten PS. Something personal you know about them. How’s the kids? Been out on your boat yet? See you at the next Kiwanis meeting.

Send out 5 letters a day, then a week later follow up by calling those people. “Did you get my letter? Have you thought of anyone I may be of service to?”

Before you hang up ask for their e-mall address telling them you will be sending out a monthly newsletter of Community News. A simple email that will cost you nothing but a little time. Include real estate news; Did you know that Sneaker Circus is opening on Main Street? The vacant store on 2^nd Avenue is going to be a new Bakery. Also community events, Will I see you at the Memorial Day Parade? Etc. Close every Newsletter with a PS. “Did you think of anyone I may be of assistance too.”

The key is redundancy, send your newsletter out on the same date each month, people will look forward to receiving it.  Think about the growth of your referral network adding 5 people a day, 25 contacts a week, adding 100 sources of referrals a month, for basically a half hours work each day, 10 minutes to print 5 letters and 20 minutes for follow up calls to those you mailed to last week.

Do you know any residential real estate agents? Most of their customers work and their businesses may need your services. Create relationships with as many residential firms and agents as you can. Ask them to introduce you to their customers after the house sale closes. Advise them that if you are successful in servicing their commercial real estate needs you will pay them a referral fee. Stay regularly in touch with your new client, after your initial introduction and keep the referring agent in the loop too. Business requirements are constantly changing, maybe they do not need your services this year but next year they will. Also add them to your newsletter distribution list too.

Building a referral business is creating opportunities for future brokerage. You learn a customer’s lease is expiring in four years. Record this fact in your calendar program but also talk to the customer every six months or sooner to see how their business is doing. The lease may run for four more years but the customer’s business needs may require a move sooner or maybe now they are ready to buy a building for their business.  Good record keeping is essential. Communicate regularly to develop your relationship with your new customer.

Make sure the people you do business with do business with you. Does your Dry Cleaner, Hair Dresser, Barber, Deli, Insurance Agent, Doctor etc. know what you do for a living? Next time you give them your business, also give them some of your business cards and ask for referrals.

Join or create a lead generation group. Bring together 10 people each representing a different business related to real estate moves. For example, meet regularly with an attorney, accountant, banker or mortgage company, a representative of a moving company, office supply firm, an engineer or an appraiser. Meet monthly to exchange information (leads) about companies planning expansion or moves. Each person is required to bring two leads to each meeting; have rules if someone does not bring any leads to two meeting they are out of the group. Replace them with someone else from that industry. An early breakfast meeting at a diner is ideal but for now you can do it via a zoom meeting. This referral network will eventually benefit everyone in the group.

Many of us market our properties via e-mail and social media. Consider adding a line to your transmissions, “Do you know of anyone who may be interested in this property?” Ask your customers for referrals. On all your e-mails consider adding to your signature, “Please let me know of anyone you think I could be of service to at this time. Thanks.”

Basically, every correspondence should end by asking for referrals. Every conversation should end with “… is there anyone you can think of that I could be of service too?”

Referral opportunities are all around us. Work your referral business every day. It’s simple, just ask for the referral.

Are you in compliance?

Having taught thousands of students, I frequently get to see their business cards and am impressed by their titles; Director, Vice-President, Managing Partner, etc.

Recently, I have been adding Ethics training to some of my courses, using the NAR Code of Ethics as reference. I found the following under Article 12:

“Realtors® shall be honest and truthful in their real estate communications and shall present a true picture in their advertising, marketing and other representations…Making sure their status as a real estate professional is readily apparent…”

Even though this refers to Realtors®, we are talking Ethics, which applies to all Real Estate agents everywhere.

Under Standards of Practice 12 -13 it further states:
“The obligation to present a true picture in advertising, marketing, and representations allows REALTORS® to use and display only professional designations, certifications, and other credentials to which they are legitimately entitled.”

I got to thinking about these titles I frequently see. They are technically for corporate officers of a firm. Could all these agents be owners or officers of real estate firms?

Doing some research. I found many real estate agents are granted titles by their brokerage firm. Examples include President, Executive Vice President, Senior Vice President, Vice President, Managing Director, Director, Partner etc. The idea is to enhance an individual’s stature as an effective salesperson. This is misrepresentation and would be an ethics violation.

A title of “Vice-President or Director of Retail Services” could be interpreted by a consumer that this person has extensive experience in leasing and the sale of retail properties. In fact, they may be a relatively new agent who is only an Independent Contractor with the brokerage firm. This could also create liability for both the agent and the Broker.

In New York the Department of State issued an opinion indicating that granting titles to gain marketing advantages was a false and misleading use of the titles and a violation of Article 12A of the License Law. The only titles allowed in NY are Licensed Real Estate Salesperson, Licensed Associate Broker and Licensed Real Estate Broker.

NY Real Property Law, Section 441-c, allows the Department of State to revoke, suspend, fine or reprimand a real estate broker or salesperson if that licensee is found to have: Violated any provision of Article 12-A of the Real Property Law.

In our profession our reputation is everything, we must be ethical and do the right thing. Are you and your firm in compliance? If you have inadvertently been using an inappropriate title now is the time to correct it.

Pandemic Marketing – Back to Basics

As a result of the covid-19 virus there are many opportunities for commercial real estate agents to help struggling businesses and themselves. Businesses may be looking to downsize by moving or by sub-leasing some of their space if stuck in a lease. Some maybe facing closure and are looking for a replacement tenant for themselves to entice the landlord to release them from their lease obligations. How do we find out, we talk to them, the old fashion way, face to face. Visit businesses in town, using social distancing and wearing masks. See if you can be of assistance to them.

Note: New York State still has a ban on “Cold Calling” but that is specific to phone calls.

This in person “Cold Calling” is a business building activity we should have been doing before the pandemic arrived. Basic marketing “101” tells us to spend some time each day prospecting business for the future. One technique is to systemically go door to door introducing yourself to all tenants and building owners in town. Visiting a minimum of just two business a day, that’s 10 a week, 40 a month, new prospects. Meeting current tenants and owners now may be timely to help them, and it helps develop your presence in the community as "the commercial go to person".

Now that you have made initial contact you want to stay in touch. If you meet a business owner who is a tenant determine when their lease is up. To catalog this valuable information you can buy all sorts of software programs or you can simply use the “word” and calendar programs found on most computers.

You determined their lease is up in 2 years; enter in your calendar program to follow up on this 6 months prior to the lease expiration. However, you also want to regularly stay in touch, so enter a follow up visit date in 3-4 months; these subsequent visits continue to develop your relationship with the potential client. With each visit end by asking for a referral "is there anyone else you know, that I may be able to help?"

If when their lease expires they decide to stay in their location, consider them a source of referrals or a potential buyer (more on that in a moment) until they need to move.

Just because someone signs a 5 or 10 year lease does not mean they will stay there the entire time. Business is booming and they need more space, thing are slow they need less space. We can help them find new space and possibly sub-lease the space they are in. (and get paid for it!). By repeat visits if they need to make a move, you are top of mind and you get the call.

Each time you catalog a building set up a simple “word document” about the potential client you just met. Include whatever information you have gathered, name, address, owner or tenant, type of business, how much space they occupy, when they expect to move and lease expirations. Include any personal information they shared with you about their family, etc. You learn they are going on vacation next month. Keep this chronological record of activity for each call or visit. Before you talk to them again consult your log. You may want to begin your conversation with a question like, “How was your vacation? This type of personalization develops relationships.

In your initial visit you learned they lease 2,500 SF of retail space. Set up files in your computer by size: for example, retail tenants leasing 1,000 – 2,000 SF, 2.000 - 3,000 SF, etc. When you list an retail building for sale in the area a bit larger, say 4,000 SF email the opportunity, to all your retail tenants leasing space less than that, they may be ready to buy! Do the same thing for office and industrial tenants.

Don’t forget about building owners; in prospecting you meet the building owner, they may have their business in this building or not; either way they are an investor. Your investor files can be cataloged by size, price category or both. Get those new investment listings out to these buyers.

Taking the extra time to really catalog all you learn, leads to future business.

Situation Critical

Time is running out for the Hospitality and the Airline industries. The Covid-19 Pandemic has devastated those industries. Nationally, according to the American Hotel and Lodging Association, as of November, 2020, 57,180 hotels in the U. S. have closed and they predict that unless the industry receives Federal assistance another 71% of remaining hotels will not be able to survive another 6 months. Jobs lost in the Hospitality industry total 1,918,827 and that number could double if more hotels are forced to close. The tax revenue lost to the States and Local governments has reached over $16.8 billion dollars.

Most major cities throughout the country have been exceptionally hard hit with covid-19 and the subsequent restrictions. Tourism is practically non-existent as is business travel both contributing to empty hotel rooms. In New York City the following hotels have permanently closed: Hilton Times Square, two Courtyard by Marriott’s Herald Square and Fifth Avenue, Omni Berkshire Place, Blakely, Maxwell, New York Marriott, W, New York Downtown and the Excelsior hotel. Also closing is the Roosevelt Hotel, a city landmark that has been open almost 100 years, built in 1924, named for President Teddy Roosevelt

In a report on the Hotel industry by Price Waterhouse Cooper they interviewed Vijay Dandapani, President of Hotel Association of NY, representing 300 hotels in NYC. He indicated that in the summer of 2020 only 7% of the city’s 120,000 hotel rooms were filled. In 2019 occupancy was 80%. As of September 58%, of all rooms were still closed, a hotel is losing money with only 40% occupancy. Hotel Revenues have declined 81.6% over 2019.

The vast majority of hotels in the city cannot pay their property tax bills, and to make matters worse NYC is charging hotels 18% interest on overdue property taxes: during this pandemic! Dandapani said, “We are not asking for a tax break or a handout. We are merely asking not to be penalized for late tax payments so that we can keep our doors open and keep workers employed.”

According to a report on CNBC, 34 percent of the hotels in New York City are delinquent on their debts. The report quotes an executive at a leading hospitality investment bank as saying the closures thus far are merely “the tip of the iceberg,” with more likely to follow – especially in the Times Square/Midtown area.

Dandapani also said: “If half of the city’s 640 hotels survive it would be a great outcome.” CBRE is calling 2020 the worst year for hotels since the Great Depression.

The real question now is what to do with these closed hotel buildings. In most areas, larger cities have a housing shortage, particularly of affordable housing. Some of the hotel owners and investors are considering converting these buildings to residential use.

That may be easier said than done, with concerns for zoning changes, building codes and costs of conversion. Traditional hotel rooms will likely require extensive renovation to add kitchenettes. Hotels that cater to business travelers may contain a lot of meeting and event space that will have to be redeveloped. Most of the units would probably be studio size but adding a connecting door between two units could make if “family” size.

Converting traditional hotels for senior living could solve some of these problems. Common areas can be used for craft and activity rooms. If the operator is offering assisted living, room sizes can remain small and meal service can remain centralized.

The best opportunity for conversions are extended stay hotels and motels. They have the advantage of already having a bedroom, bathroom, living space and a kitchenette, all in the unit. Consequently, they will not require extensive and expensive modification of existing mechanical, electrical, and plumbing systems.

In NY Gov. Cuomo has proposed a five-year plan to incentivize the conversion of commercial buildings and hotels in NYC into residential units. The plan would easy the zoning restrictions on light and air requirements for those conversions. Under the proposal, hotels and offices can go residential if the owner agrees to set aside at least 20 percent of the apartments as affordable housing. Details of the plan have yet to be worked out.

Airlines

In a report from Airlines for America the demand for air travel is depressing. In May of 2020 air travel was down 89%. As of October 2020, over 20% of all aircraft in the U. S. were in storage on the ground. According to the TSA, who counts air passengers on a daily basis, on January 16, 2021 there were 690,438 people flying verse the same day a year ago when 1,781,893 people flew: 61% less passengers this year!

A CNBC report stated the expected losses for the U. S. airline industry for 2020 will top $35 billion. United Air Lines had reported losses last year of $7.1 billion and Delta Air Lines lost $12 billion in 2020. Over 30,000 workers have been laid off because of the reduction in flights. In January 2021 total air passengers were only 45% of 2019 levels.

Airlines for America President Nicholas Calio said, “We’re flying fewer people than we have since the start of the jet age in the 1950’s.” The airline industry is unlikely to financially break even in 2021, and it will take years to recover from the additional covid related debt. They don’t expect to resume pre-covid passenger volume until 2023 or 2024.

Both industries are truly fighting to survive, and both are counting on the federal government for assistance. We do not know what is in the next covid-19 relief bill or when or if it will pass Congress. But we do know with vaccines now being distributed this pandemic will come to an end.

This news about these industries sounds grim but think of the real estate opportunities for developers, investors and Brokers.

Repurposing buildings is a viable alternative for the hotel industry and other commercial buildings but solving the airlines problems is another issue. But if some airports were to eventually close, we in real estate could help with the land redevelopment.

What’s Next

The first deliveries of a Covid-19 vaccine are bringing optimism back to everyone weary of the virus, the lockdowns, and the restrictions. We must all be patient and continue to be safe, wear masks, social distance, frequent hand washing and minimal gatherings with family and friends.

One of the things we expect to see in 2021 are rents dropping in several sectors. As a result, building values would decline and CAP rates would increase. This should, especially with the low interest rates, entice investors to come off the sidelines and start buying again.

Office

The office sector has been dramatically affected by the pandemic. Companies are concluding the work-at-home is reducing their
requirements for space. Some are considering a permanent 3/2/2 work schedule, rotating employees in the office. Work from home three days a week, in office two days and two days off each week. Bill Gates, the founder of Microsoft, has announced that his employees can work from home permanently for at least 50% of their working hours. He also predicts that 30% of “office life” will not exist after the pandemic and a 50% reduction in business travel.

Large Cities are experiencing the highest office vacancy rates in years; Los Angles 15%, Chicago 15.3%, San Francisco 20% and NYC 14.9%. Such large vacancies will certainly drive office rents down.

The Real Estate Board of New York (REBNY) is looking at the office vacancy in NYC optimistically, pushing the idea of converting upwards of 210 million square feet of “less than luxurious” office space to apartments and condos to help deal with the general shortage of housing units, especially affordable housing.

Another problem is getting workers to return to working in their office buildings, concerns for the filter systems in those building and mass commuting exposure issues.Nationally about 25 percent of employees had returned to work as of Nov. 18, 2020 the Wall Street Journal reported, citing data from Kastle Systems, a security firm that monitors access-card swipes in 10 major U.S. cities. While that is up from the low point in April of less than 15 percent, it represents a slight dip from the high point of 27 percent in mid-October, this is due to the current second wave of the virus. The lowest return to work cities are New York City at 15.9% and San Francisco at 13.4%.

The President of the REBNY, James Whelan stated in October 2020 only 10% of NYC office workers have returned to their offices. He also said, “It would probably be fair to say we haven’t hit bottom yet.”

But another more optimistic group JNY Capital and United Hoisting Co. are developing a 425,000 square foot “Green” office building at 38-42 12^th Street in Long Island City. Called “The Oasis” the building will be built to “Passive House Office Standards”. Which were first developed in Germany, passive house specifications require buildings to use ultra-low levels of energy, usually using insulation systems that require less heating and cooling, it will also have solar panels, a green-roof system and a high efficiency mechanical system, among other features. A rendering is below.

“We have created an eco-conscious building that offers a safer and healthier office environment for workers to return to and a benchmark for sustainability and innovation,” said JNY vice president Moshe Pinsky, who added the project is expected to break ground in the first half of 2021.

Retail

The tracking firm, Retail Next said the foot traffic on Black Friday 2020 was down 52% in the North East over 2019. Buyers are still hesitant to return to “normal” in store shopping. Unfortunately, more store closures, especially in Main Street areas, are expected.

But not all the retail news is bad, J.C. Penny’s, who declared bankruptcy in May 2020 as a result of store closings due to the Covid-19, is back in business. Two of their major Landlords, Simon Property Group and Brookfield Property Partners purchased 160 of JCPenney's real estate assets and all of its owned distribution centers.  But the company also plans to permanently close nearly a third of its 846 stores as part of its restructuring, which would leave it with just over 600 locations.

In retail Landlords and Tenants working together to find solutions is today essential. With many stores closing, especially restaurants, the rents will be going down in this sector too.

All of this available inventory is creating opportunities for real estate agents throughout the Country.

Multi Family
In Multi-Family we previously reported a mass exodus from large cities, in New York City there are now over 15,000 unrented apartments. However, according to Douglas Elliman, the average rental price in Manhattan in November was $2,743, a decline of 22%. This and Landlords offering significant incentives on new leases created a surge with over 4,000 residential new leases signed in November 2020. That is an increase of 30% over the same month last year. CoStar reports the San Francisco residential rents have fallen by over 20% since March. In addition, Nationally Multi-Family rent collection was down 24% in December 2020 per a Globe Street report. All indications are residential rents, especially in the larger cities, will decrease in 2021.

Covit-19 Continuing Updates

Social Distancing has made our business more difficult and challenging. The effects of the pandemic are being felt throughout our Commercial Real Estate industry.

On November 18, 2020 I gave a webinar for the long Island Board of Realtors, “Non-Essential Challenges” The Impact of the Covet-19 Pandemic on Commercial Real Estate. Even though it focused on Long Island and New York City properties, most of what is happening there is also occurring throughout the North East. Below is a link to the 50-minute report. Followed by some of the key findings and some additional updates.

https://youtu.be/QT7rLbFj1Yk

Office 50% Occupancy

Work from home full or part time – some like it, some hate it, but it is here to stay.

Moody’s Analytics has predicted office vacancies in 2021 could reach 20%. Projections are 15-20% of the office workforce will permanently work from home or a company will rotate who is in the office by having employees only come into the building only 1 or 2 days a week. Cushman and Wakefield are predicting a loss of 145 million square feet of office space nationally in 2021. This type of vacancy level creates competition that reduces rents. reduced rental income lowers building values.

Mark Zuckerberg said as many as 50% of Facebook (FB) employees could be working remotely within the next five to 10 years.

With 50% occupancy less space is required, due to less employees in the space at any given time, but this Is currently offset because of more space being required for social distancing.However, some businesses are consolidating locations, and some are closing so we are seeing an increase in vacancy.

Tenants with short term leases are in a good negotiating position because landlords are afraid of vacancy. They may be able to get rent reductions or deferrals now. And negotiate to rent less space in the future with further rent reductions, in exchange for renewing their lease.

People want to socialize!  After the vaccinees are distributed and health situations are under control the social distancing may become relaxed in our office buildings. With the work at home still in play this will create more excess space. Sub-leasing their surplus space or moving to downsize will be options; either way expect more office vacancy.

Office Subleasing Explodes

There is a new report out by Colliers International focusing on the Office sub-leasing markets. Nationally Class-A asking rents in Central Business Districts are down by 2.7%, and sublease space is currently leasing at an average 23.9% discount compared to direct lease space. This is above historical discounts for sublease space which has been around 20% below market rate. 

Jonathan Adelsberg, a partner and chair of the leasing department at law firm Herrick Feinstein LLP, told the New York Time,“Given the plethora of space on the market today, we expect to see discounts greater than that,” he said.

In the second and third quarter, the supply of sublease space increased by 35% to 170 million square feet. In NYC sublease supply reached 3.1 million square feet on the market about 23% of the total availability office space.

On Long Island the LI Business News reported 782,000 SF of office space available for sublease in Q3 2020. This is up by 52% over Q3 2019.

Restaurants Fight to Survive

CBS’s Sunday Morning show gave some frightening new statistics about restaurants. Nationally 1 in 6 restaurants have closed so far: that’s over 100,000 restaurant businesses!

This sector of the industry has seen tremendous turbulence. This is a Nationwide problem.

In NYC for example, a record high 88 percent of restaurants could not pay full October rent, according to the latest survey of more than 400 restaurants, bars and nightlife venues by the New York City Hospitality Alliance. That percentage has gradually increased throughout the pandemic.

Andrew Rigie, executive director of the NYC Hospitality Alliance, said “Going on eight months, more than 24,000 restaurants, bars and clubs citywide that are so critical to New York’s economic and social fabric have been in dire straits,” Of those who could not pay full rent, 30 percent paid nothing at all.

Some restaurants have managed to make new arrangements with their landlords. Forty-one percent have had rent waived, with 68 percent of those seeing half or more of it waived. Thirty-three percent have received deferrals. It is expected that at least 30% of all restaurants in the metropolitan area will permanently close.

The struggling industry is getting creative and NYS City is trying to help. Outdoor dining has been allowed in NYC since the City entered phase 2 in late June. Over 10,700 restaurants have opted-in to the Open Restaurants program. It has proven to be one of the few lifelines for the restaurant industry during this devastating period; because of that,

Mayor Bill de Blasio announced at the end of September that outdoor dining would be made permanent and year-round.  Heat lamps are permitted, as are tents and structures. The NYC building code defines “Outdoor space” as an open-air space designed for the consumption of food and/or beverage, which may have a temporally or fixed cover (e.g. awning or roof) So long as such cover has at least two open sides for airflow. With such outdoor space tables and seats must be at least six feet from any other table, Seat, patron, pedestrian throughfare or corridor…

Another big issue everywhere, especially in cities, are the number of municipal workers who have not returned to work.

With most offices holding at a 50% occupancy level and the large work at home population, all levels of government have slowed down.In a Globe Street report, they tract returning workers in 10 major cities,New York, Washington DC, Chicago, Boston and others, which are averaging only 27.1% of employees returning to work. NYC has the lowest return rate where only 16.9% of City employees have returned to their offices.

So, the process of getting building permits, zoning changes, certificates of occupancy, everything we need for sales and development has slowed down tremendously.

Retail

A prolonged closure due to the Pandemic has forced many small businesses to close. To stay open, negotiating with the landlord about the rent became a necessity. With closures and lease defaults, there is expected to be a lot of retail space to rent. Vacancy is the “kiss of death” for Landlords. It is in their best interest to work things out with existing tenants, even if they must forgo rent for a few months, it may be a better choice than having vacant space. They can add the months the rent that was forgiven for to the end of the lease. Tenants can offer to extend their leases for rent deferment too.Another solution that could help both sides might be to temporally pay a percentage of the store’s monthly gross income in lieu of the rent.

Landlords must also consider; with all this available space it would mean that new tenants will be in a strong position to negotiate favorable terms and lower rent. So, we can expect to see rents decrease. With rent decreases we would expect building values to decline too. However, with interest rates going lower and lower, Landlords who retain their tenants can refinance and lower their debt service costs. 

A report from Jones Lang LaSalle states that the growth of these fulfillment and distribution center will require another billion square feet of industrial space by 2025.

2021 Here We Come

Muhammad Ali famously said: “Don’t count the days, make the days count.” Ali is known for his wit and wisdom, and, as we hit the seven-month mark of the pandemic, this quote has meaning well beyond sports. 

As we get used to the new normal and the pandemic drags on, it is more important than ever to make every day count. We are in the fourth quarter of the year, which means it is time to start thinking about your business plan for 2021. As you plan your strategy to accomplish your next year’s goals always focus on the basics:

Build Relationships

Develop safe ways to connect with your clients, past and new, to continuously strengthen relationships. Set an example by wearing a mask and social distancing.

Be a “value added” agent regularly provide your clients with current information about the market, financing, and more via mail and email. Create a monthly electronic Community Newsletter.

As you build your relationships, your connections will tell their friends and family that you are the one to turn to for anything real estate!

Develop NewOpportunities

Prospect for at least one hour every day, to keep your pipeline of opportunities full. Lead generation must be consistent. Write a personal note to five people from your sphere of influence list each day and follow up the following week with a phone call, chat a bit (you know them) and  ask for referrals, “Do you know of anyone I could help?” Get their email address and add them to you Newsletter distribution list.

Systematically visit two business in town daily, get to know all the tenants and landlords. Catalog their information in your computer and calendar a follow up visit. Periodically stop by some of your past clients, see how their business is doing.

Read the classified ads, call the FSBO’s and make an appointment to see their building or space. Do the same thing with MLS expired listings.

Education Never Ends

The more you know the more professional you appear. Sure, you must take continuing education, but select courses the will teach you something new, consider earning a Certification or Designation. Read the business and trade papers like the New York and New England Real Estate Journals, keep abreast of the transactions in your area and what is going on in our industry. Read books on real estate, finance, negotiating and self-motivation.

Build Your Business and Track the Results

Try something new! Develop as many ways as possible to build your business and most importantly track where every lead you get comes from. Periodically review what is working for you and what is not, until you have 6-8 or more methods that consistently build your business.

Are you regularly doing direct mail using the Post Office’s Carrier Route delivery service, usps.com/business/every-door-direct-mail.htm? Have you established a referral network of agents that only do residential? Are you giving seminars? Do you work the trade shows? Have you started your LEADS group? Are you doing daily telemarketing and cold calls? Are you doing cheap advertising in the form of press releases? Are you keeping your personal website fresh and up to date? Do you review the commercial listing services websites daily for new listings in your area and comparable pricing information? Are you posting all your listings on social media?

Networking

Get active in the organizations that your potential clients are in. Join the local Chamber of Commerce and Service Clubs like Lions, Rotary, Kiwanis, etc. (they are all good). Even if they are temporally meeting virtually.

Many Realtor Boards have Commercial Divisions, get involved. Remember on the commercial side of real estate about 75% of your deals will be a co-broke. You need to make alliances with the commercial agents from other firms in your area; they may have the buyer or tenant for your next listing.

The virus has changed some of the way we do business now, but the basics of annual goal setting and planning continue to be necessities of success.

Focus on Leasing

This is a reprint of an article I did in March 2009 at the height of the Great Recession.

Given the current economy we see a lot of activity in the leasing arena. Business is on the move, some are growing, some are shrinking; leases expire. Landlords are certainly doing all they can to retain or attract new tenants: reducing rents, forgiving escalations, offering concessions. The landlords fear is vacant space, interruption of their cash flow. This gives tenants today an edge in the lease negotiations.

As agents we have to remember it is our job to negotiate all the issues in the lease and almost every issue relates to money in one way or another. We also have to focus on who we are representing and do what is in their best interests.

The leasing process needs to begin with determining the “wish list” of our client. When representing the landlord we need to know the square footage of the available space and the base rent per square foot. But we also need to determine if there is common area in the building that the tenant will be expected to pay for. Are there any “pass through” expenses in addition to the rent, i.e. utilities or CAM charges? Who pays the real estate taxes? How much security will be required? Is signage and parking included? Who pays for repairs? We need to understand the landlord’s position on every detail. We need to get this information when we take the listing.

You don’t want to show the space and have a potential tenant ask a question you cannot answer.

Representing the tenant requires the same information gathering. Remember tenants are not in the real estate business; maybe they do a lease every 5 or 10 years. They need our guidance. Go to their existing operations; help them determine how much space they really need. Observe the number of employees, as this will relate to parking requirements. If office space is desired determine for whom? Analyze how much space a clerical worker uses, look at the size of a manager’s office. How big is the conference room etc.? Helping a retailer determine needs must also include discussion of how goods are delivered to them; will they need a loading dock? Where is their inventory stored (don’t forget that basement space)? Industrial building expansion may just need a building with more ceiling height!

Another set of questions for a tenant concerns their budget. They may just be focused on overall monthly cost. We may have to educate them to “our language” or do the math for them when presenting a building with loss/core factors or pass through expenses. A key question is where do you see your business in 3 years, 5years? The answer can help us place them in a free standing building or a large building with potential for future expansion.

Developing a “wish list” for whoever you are representing is the first step in leasing. Then look at what is most important to your client. Establish priorities for the upcoming building or tenant search and negotiations. Also think creatively.

Helping our client’s starts with communication, it’s a great time to contact landlords and tenants.

Postscript added today:

Many landlords are trying to work creatively with tenants that are in trouble in both the office and retail sectors.

In office sectors landlords are getting requests, especially from tenants with relatively short terms remaining on their lease, for Tenant Improvement Allowances. To provide the tenants with the funds to reconfigure the space to social distancing and safely guidelines. Tenants may also request a rent reduction. Landlords may consider these things to keep the tenant if the tenant will sign a new lease or extend the current one. Concern being in many markets’ vacancy is increasing and as it does rents will come down.

Vacancy increasing is even more prevalent in the retail sector. Here landlords are taking a hard look at the tenant’s probability of survival.

Based on the strength of the tenant a lease modification may be considered. The landlord may defer one to three months base rent to the end of the lease with the requirement that the lease be extended for that period. Most retail leases are Triple Net, so this would be in the form of a Rent Abatement, where the tenant continues to pay the operating expenses and taxes during that time. Language may also include that if the tenant does default on the lease, these monies would be added to the default.

Another concept to help the tenant and to help the landlord to continue to pay their mortgage expense is to temporally convert the lease to a Percentage Lease. The tenant will pay a significant portion of their monthly gross sales to the landlord in lieu of base rent for the remainder of the Covet-19 crises.

Unfortunately, not all landlords and tenants will work out their difficulties defaults and evictions may result. Visit the small businesses in your area, maybe you can help them negotiate with a landlord, of find them new smaller space. Also contact the landlords in your area, see what space they have or will have available. Seek out these post-pandemic opportunities.

The Changing Office Environment

In the “old” day’s office space was figured at 250 SF per employee, with each employee having their own desk and a significant number of private offices. In the 1980’s the firm Ernst and Young realized that most of their work force spent most of their time out in the field rather than in the office. They invented the concept of “hoteling”, reducing the number of desks and private offices, by having employees share them. Employees would schedule an appointment to use desk space as needed. The overall amount of space needed for their offices was dramatically reduced to 100 SF per person.

As time went on some firms followed the model, others modified it by eliminating most of the desks and replacing them with assigned cubicles next to each other. This reduced the overall space requirements to around 150 SF per employee, but they each had their own space.

Today, because of the pandemic, the design of “efficient” office space will be changing again. The work at home, part, or full time, will be continuing in many firms. But social distancing and other requirements ensuring the health and safety of the workers must be incorporated into the workplace. This will certainly increase the necessary square footage per person offsetting the space reduced by the at home workers.

Most States have developed Covit-19 Guidelines and some States are mandating changes. Some of the common directives are:

Rearranging the office space so there is 6-foot distance between employees and to stager the desks or cubicles to avoid sitting opposite another person. In addition, install partitions between workers.

Reduce occupancy to 50% and minimizing visitors.

Where possible create clearly marked one-way traffic flows and install social distance markers to remain 6 feet apart.

Segment the space into work zones and encourage employees to remain within their workspace; discourage non-essential walking around.

Minimize employees using shared equipment, and clean after every use.

Provide hand sanitizer throughout the office

Close or remove non-essential amenities (i.e. coffee station, coat room) where employees would congregate. Close the conference room; use virtual conferencing instead.

Stager working hours, allow work at home, full or part time to reduce the number of employees in the office at any given time.

Post signs and train employees on the expected office protocols for social distancing and using elevators, cleaning and disinfecting, personal protection (use of masks and gloves), and to stay home if they feel ill.

Ventilation is a major area of concern. Where possible increase the amounts of outdoor air coming into the building and increase ventilation rates. Buildings should have or install High Efficiency Particulate Air Filters with a Minimum Efficiency Reporting Value (MERV) rating capable of filtering Covid-19 particles. A MERV rating of 11 or 12 is OK, but a MERV rating of 13 is most desirable.

This has created a problem in New York City which has current laws that all building over 25,000 SF must have their building “Benchmarked” and file an annual report. Benchmarking is measuring how much energy, electricity, and water the building uses and the amount of carbon emissions the building produces.

NYC Local Law 97 a part of the Climate Mobilization Act enacted in May 2019, is focused on reducing buildings carbon emissions. The law established carbon emission limits for every type of building. Starting in 2024 building owners must submit an annual Carbon Intensity Report and if their buildings carbon emissions exceed those limits, they will be subject to sever fines. The problem is the MERV air filters will combat the virus but the more outside air you bring into a building and the higher rated your filter is, the more energy you will use and more carbon emissions are created. This is a new issue that has yet to be resolved. The NY Governor has mandated the use of these MERV filters in Malls in NY.

Who is going to pay for these health and safety capital improvements to buildings? The owners are!

However, under the Coronavirus Aid, Relief and Economic Security (CARES) Act Qualified Improvement Property was made eligible for Bonus Depreciation. 100% of the cost of the Qualified Improvement Property can be taken as Depreciation in the year it was purchased. This is defined as any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property if such property was placed in service after the date the building was originally placed in service. However, improvements related to the enlargement of a building, any elevator or escalator, or the internal structural framework are specifically excluded from the definition of Qualified Improvement Property.

Effective in 2018for nonresidential real estate roofs, heating, ventilation, air conditioning, fire protection and alarms and security systems were added to the Qualified Improvement Property definition. So, all the expenses we have discussed related to making the workplace safe, will qualify for the Bonus Depreciation. As always everyone should discuss any tax matters with their accountant or tax advisor.

Websites must be Americans with Disabilities Act (ADA) compliant

The word “website” does not appear anywhere in the Americans with Disabilities Act. In fact, when the ADA was signed into law, by then President George W. Bush, on July 26, 1990 there was no internet and websites did not exist.

However, over the years the U. S. Courts have ruled that ADA regulations are applicable to websites. This is based on Title III of the law which defines that ADA is applicable to businesses and nonprofit service providers that are public accommodations, privately operated entities offering certain types of courses and examinations, privately operated transportation, and commercial facilities. “Public Accommodations” has been defined as any building open to the public. The U. S. Courts have interpreted “Places of Public Accommodation” to include the internet and specifically websites.

In 1999 Web Content Accessibility Guidelines (WCAG) were developed, expanded in 2008 and again in 2018. Currently WCAG has 38 requirements (many of a technical nature) required for compliance. The goal is to make the content of websites usable for people with vision or hearing impairments and those who have cognitive, learning, or other physical disabilities.

With the coronavirus closings of schools and work places, a work from home and home schooling environment was created. This accented the use of computers and the internet which many folks with disabilities found difficult. It has also created a significant number of lawsuits against website owners for ADA violations.

Follows is an article published by 3 Media Web’s Technical Manager Mike St. Jean.

“7 Steps to Design an ADA Compliant Website”

“So, how can you create an ADA-compliant website? Here are seven steps toward building a more inclusive site and adopting the WCAG.

1. Evaluate Your Current Site
First things first: What is the state of your current site? You can rate your own site using programs like WAVE or Lighthouse and by manually testing the site with screen reader software. To be ADA-compliant a site must meet standards within four categories: Perceivable, Operable, Understandable and Robust. Use the ADA guidelines as a starting point to create a blueprint for your own site.

2. Choose the Right Graphics
Carefully chosen graphics are a big part of accessible websites. When you’re including graphics, they should not flash more than three times per second. Any more flashing, and you could inadvertently induce a seizure in someone who is browsing the page. Graphics should also have a description/caption that can be read aloud to the visually impaired. If you have informative or fun visual content, you want everyone to be able to enjoy and learn from it!

3. Add Alt Text and Readable Fonts
Making your site perceivable for all potential users takes a lot of thoughtful choices. A variety of things fall under the umbrella of perception. To get started, provide alt-text for all images in your code. Alt-text captions allow site readers to describe your images audibly.

Fonts are another crucial component of accessibility. Use fonts that are easy to read, such as Georgia, Open Sans, and Quicksand. Avoid putting a light font color on a light background; a combination like yellow text on a pale background causes people to strain to read it. Equally problematic is a pale font on a stark black background. Stick to light backgrounds with dark for most of your content.

4. Make Website Features Logical
An ADA-compliant website must also be understandable to a wide audience. The site should operate in a predictable way and have helpful labels over blocks of content and media. For example, put a clear “x” in the upper corner of a pop-up to show users how to close the window. The site should be built in a way that avoids user error and has readable instructions on all forms where users are expected to enter information.

5. Code Your Site with Standard HTML Tags
The robust requirement of ADA recommendations is the most technical one. It basically means the code should be readable by an assistive reader. The code on your site must use standard HTML tags. You should also provide documents in a text-based format at all times, even when you also offer a PDF. Complex image documents can’t be understood by software that reads text aloud for visually impaired website users. The good news is that most website platforms, including WordPress, are designed to operate using modern code format.

6. Make the Site Keyboard- and Pause-Friendly
The primary function of the “operable” category of ADA standards is to ensure your site can be navigated using a keyboard alone. Not all users are able to interact with a touchscreen or grip a mouse. This category also relates to the overall navigation. For instance, readers should be able to pause content or slow down automatic scrolling/slideshow movements. Eliminate any videos that auto play and have a time-limit. And, of course, make sure that all video interactions and pausing can be completed using keyboard functions.

7. Remain Up-to-Date on Compliance Changes
Remember that ADA needs are ongoing. As new technologies are made available for people with disabilities, they should be accounted for in your web code. A good start is making sure the text easily readable and the code works with assistive readers, it’s true. But a truly compliant (and usable) ADA-compliant website will adopt new best practices as they emerge.”
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Negotiations Today

As real estate agents we negotiate every day with potential clients to get an exclusive listing and for our commission fee. We then negotiate for our client to get them the best deal possible. If representing a buyer or tenant, we present their offers and work to get them a good deal. We also negotiate with other agents and brokers regarding referrals and co-broke arrangements.

Negotiations require research, preparations, and delivery. Delivery is composed of what we say (the words), how we say it (tone) and body language (facial expressions and physical gestures).

Traditionally real estate transactions begin with a purchase offer or a Letter of Intent (LOI), then the negotiating period occurs, a back and forth modification of positions, often by revising documents, communicated by email, until an agreement is made.  

But in the last several years, leasing has become more personal; potential landlords and potential tenants want to meet each other.

Considering they are entering into a long term business relationship, the face to face meeting makes sense. Agents have always been taught to never put the parties together for fear they would go around the broker.

But today’s consumer thinks trust first, then business, in dealing with both their agent and their choice of landlord or tenant. Sometimes the final terms of a lease are discussed at theses onsite meetings or at a more formal in person conference. Agents are getting used to this idea and are now finding bringing the parties together, with you of course being there, helps get an agreement.

The getting to know each other concept evolves into the negotiations. The biggest advantage of face to face meetings is being able to read everyone’s body language, which may speak differently than what is being said. [Some study of body language is highly recommended.]

Then came the corona virus! For the last three plus months negotiations have gone back to the old fashion way of emailing LOI’s back and forth. It does seem fewer deals are getting concluded. As we move forward with the recovery, we have new rules, no handshaking, social distancing and wearing face masks. Getting to meet, trust and communicate with our clients and between the potential landlords and tenants, in person is a challenge.

The good news most everyone has learned to adapt to video conferencing with programs like zoom meetings. We may not see the other persons full body, but we can see their face, without a mask! With that facial expression talking to us too.

It is projected that the new normal for commercial real estate will have consumers initially viewing less buildings in person. They will now expect to see videos of available commercial properties online. Those meetings, bringing the parties together, will be now done virtually and negotiation sessions will also be done as video conferences.