At least in the San Francisco Bay Area, it’s as if the nation’s real estate crisis never occurred.
“It’s an anomaly. Primarily, it’s due to the location. This corridor is unique because of the jobs in Silicon Valley, the biotech companies and the job base in San Francisco. Salaries are competitive and that increases values in the housing and commercial real estate markets,” says John Dooling, a partner at Ropers Majeski Kohn & Bentley PC.
“Also, there’s no place to build. There’s little vacant land, and it sells at a premium. The real estate market has bounced back with a vengeance,” he says.
Smart Business spoke with Dooling about the state of the commercial real estate market and what that means for businesses looking to buy, sell or lease properties.
How are investors affecting real estate?
There aren’t many good places to invest money at the moment, so real estate is attractive. It’s not only smaller investors but also larger ones that are buying properties.
Investment properties are being bought up by hedge funds and large players, whereas there used to be more local buyers. Now, national players are coming in and buying what were considered smaller properties.
For leases, rental rates are approaching the highs of the dot-com boom. It’s very difficult for businesses trying to find a space, or if their lease is expiring, it’s becoming an expensive proposition.
Midsize clients are taking advantage of industrial space. If they can occupy the space, financing rates are attractive and U.S. Small Business Administration loans can help. So, there are some opportunities in the right sectors.
The large demand for commercial properties, especially apartment buildings, has driven capitalization rates down to historically low rates below 5 percent; they’re usually around 7 or 8 percent. But as interest rates go up, as anticipated, it’s going to be difficult for these buyers to get value out of their properties. Inflated prices and low cap rates reduce ROI.
What are some important considerations when buying or selling?
Obviously, location and price are important, as is creating a separate entity, often a single purpose LLC, to purchase the property.
From a legal perspective, you also need to do your due diligence. There is no standard transfer disclosure statement for commercial properties. If the building has one to four units, there is a statutory requirement that a transfer disclosure statement be completed, which does not apply if there are more than four units. So, a buyer must have a good property inspection; investigate the title, not just put the title report in a drawer; conduct an environmental study; and research the permit history of the building. Buyers could have an issue with a property years down the road that leads to litigation with not only the seller, but also involving a contractor in a construction defect lawsuit.
From the seller’s perspective, it’s important to disclose any material issues related to the property. Another concern is the contract. Preprinted contracts are more commonplace but still require careful consideration, including whether you want to arbitrate a dispute and liquidated damages.
Agreeing to the arbitration clause waives the right to a jury trial. That’s not necessarily the wrong thing to do, but it has implications. The arbitration process can sometimes be more expensive than court. Also, other parties involved in the transaction, such as a real estate broker or contractor, may end up being defendants and would not be bound by the arbitration clause, causing duplicate lawsuits. The point is that there are provisions in a standard contract that shouldn’t uniformly be agreed to and initialed.
Are any problems arising in commercial leasing because of the robust market?
Tenant improvements are always a big issue on the front end, and landlords are less likely to shoulder the costs now. Tenant costs are increasing, not only in terms of effective lease rates but also the cost of getting into a space. It’s important to have a good tenant build work letter that sets forth rights and obligations of the tenant and landlord relative to the build out.
Finally, as with any large transaction, it is prudent to consult with the appropriate professionals to assist you in your real estate transaction.
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