Tips for first-time commercial property investors

Investing in commercial property is a great opportunity, but it means more than just accepting checks from tenants. 

“Property owners must pay attention to the asset to make sure it stays in good shape — both in terms of structure and occupancy — because eventually it will be sold,” says George J. Pofok, CCIM, SIOR, senior vice president at Cushman & Wakefield/CRESCO Real Estate.

Smart Business spoke with Pofok about what first-time investors in commercial property should know before committing to a deal.

What should investors understand about investing in commercial property?

It’s important first to understand the market being considered and the type of product — industrial, retail, commercial office — for investment. 

When it comes to location, investors should study the market to understand the difference between the value of the bricks and mortar vs. a property’s cash flow potential. For instance, if the building goes vacant, the investor should determine ahead of time the rent that can be charged when backfilling the property. If the occupant companies at the time of the investment are paying $7 per square foot, but the true value of the market if a new tenant were to enter is $4, then the investor will need to account for the disparity between what’s being paid now and what the market will bear.  

Does investing in commercial property mean becoming a landlord?

Investing in a commercial property usually means becoming a landlord. There are absolute triple net investments through which tenants are wholly responsible for the property, but with most investments investors are responsible for the maintenance and upkeep of the main building components. This is something investors need to understand from the start. They won’t just get a check every month. They will have management oversight responsibilities. 

Where should someone interested in investing in commercial properties start?

Start by consulting with a real estate practitioner to find out what investment opportunities exist in the market — currently, industrial and multifamily are generating a lot of investor interest in the Northeast Ohio market. There are many outside investors buying into Cleveland and other Tier 2 cities, principally because the rate of return is higher than they’d get in Tier 1 markets like Chicago or Los Angeles where there’s a lot of competition, which is driving down the cap rates and creating higher barriers of entry. 

Real estate practitioners have a complete database and market knowledge. They can also connect investors who are looking to partner with others on larger properties or building larger portfolios. 

How long until investors realize a return?

Investors can make a return in that first year, as long as they invest intelligently. But how long an investment is profitable depends in part on market conditions. In today’s conditions, there is limited product and lots of investors chasing deals. Acquisition prices are high compared to recession prices, the latter of which led to conditions where cash was king and property owners were willing to take less money to solve a problem and get out. 

Who should first-time investors work with?

Talk to an attorney to make sure the corporation used for investing in commercial property is set up appropriately. In addition to the real estate practitioner and legal adviser, it’s a good idea to consult with an accountant on any real estate investment. Work the due diligence with this team, and along the way make connections with trade professionals such as roofers, structural engineers, plumbers and electricians to ensure the property is structurally sound and that it remains attractive to existing and prospective tenants. 

Also, pay attention to the tenants and make sure they’re in good financial shape because it’s a significant setback if one is lost before its contract term ends. Pay attention to lease dates and stay ahead of any renewal option dates because it’s easier to renew than to find new tenants. Many real estate practitioners watch lease expiration dates and will poach tenants when owners aren’t paying attention.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

Technology and its impact on commercial real estate searches

Technology has changed how buyers and tenants explore the commercial real estate market. Multiple online listing services showcase the available commercial properties in a given market, putting a great deal of information at a prospect’s fingertips. 

“While these services are valuable for getting a sense of the market, there’s a lot of information that’s not included that could change the value proposition of a property considerably,” says Joseph V. Barna, a principal at Cushman & Wakefield/CRESCO Real Estate.

Smart Business spoke with Barna about the role of commercial real estate brokers/consultants in an environment increasingly touched by technology.  

What information might not be available through online searches?

Listing services can’t illuminate incentives designed to court business, such as free rent, tax abatements, graduated lease rates, below-market financing or tax credits. These valuable incentives affect the total occupancy cost of a property. Buyers and tenants do themselves a disservice if they make a decision without first consulting with a knowledgeable broker/consultant who is aware of these offsets.

Lease comparisons in submarkets often aren’t tracked correctly through listing services. Brokers/Consultants, however, track completed lease transactions, which are recorded in their database after transactions are made. This real-time information can help brokers guide clients in submarkets to find the sweet spot in a deal price and structure.

Similarly, buyers can use brokers to get sales comparisons for specific types of properties in a specific submarket. Accurate, up-to-date comparisons guide buyers and tenants toward a property’s realistic true market value. With that guidance, buyers aren’t taking a stab in the dark on price. Rather, they’re making a business decision based on facts.

How has the role of the commercial real estate agent changed?

Commercial real estate brokers have become well-rounded consultants. They’re active in the market every day and, because they represent specific product types, are a wealth of knowledge in a given marketplace. 

In a consultative role, brokers talk with buyers and tenants about market trends, sale and lease prices, and provide value-added services such as project management for buyers who intend to make renovations to a property. Larger firms often have service lines to manage properties, offer guidance regarding construction/project management, incentive procurement, environmental issues and more. They help buyers and tenants consider total occupancy costs, which includes utility consumption, maintenance/upkeep and taxes incentives that could reduce the tax burden. 

Brokers also help buyers and tenants evaluate locations that meet their specific needs beyond the brick and mortar, such as access to employees, utilities, freeways and areas that are zoned for their specific intentions. These important aspects can be overlooked without a knowledgeable broker to guide the process. 

At what point in the search process is it prudent to get an agent involved? 

Online listings are a great way to get a sense of what’s in the market and a ‘snapshot’ of range of value. However, it makes sound business sense to reach out to a broker/consultant early in the process who understands the specific types of property and is armed with real-time market knowledge. 

Prospective tenants and buyers without knowledgeable representation are at a disadvantage at the deal table. Bringing a professional on early in the process levels the playing field. The end result is an informative decision based on all the critical components of a transaction. 

Most people only buy or lease property a few times during their professional lives. It’s to a tenant’s or buyer’s advantage to have the right team on their side of the table to maximize value. Real estate agents are specialists working in the market every day. They have the experience to help clients achieve their objectives.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate.

What you should be looking for in a commercial real-estate consultant

Commercial real estate consultants do more than take clients’ orders and walk people through buildings. They help clients ensure success through the entire buying or leasing process by taking the time to understand what they’re looking for and negotiate a “value add” transaction on their clients’ behalf.

“A good commercial real estate consultant will guide and lead their client through the full progression of a real estate transaction to successfully meet the client’s interest and goals,” says Simon Caplan, a partner at Cushman & Wakefield/CRESCO Real Estate. “This includes taking the time to get a deep understanding of what the client is actually looking to achieve over and above the lease or sale.”

Smart Business spoke with Caplan about the role of a commercial real estate consultant in a transaction.

Why should someone work with a commercial real estate consultant?

Real estate consultants provide clients with indispensable real-time knowledge, tools, procedures and techniques that enable them to make a more informed decision. Their access to market information, negotiating skills and their ability to manage the various components of the transaction provide the client with tremendous value. 

There are many steps in purchasing or leasing a building or space and it is a complicated process. For example, commercial real estate consultants help those who are buying buildings or leasing a significant space secure government incentives, such as abatements and tax credits. No one wants to be in a position in which they have a building under contract and the municipality turns down the use. Real estate consultants will protect their clients’ interests. 

What are the traits of a good commercial real estate consultant?

A good real estate consultant first needs to fully understand their assignment. They need to ask their client the right questions, really listen to the answers, then dig deep for information. A good real estate consultant will interview multiple positions at a company and then review the responses with the decision maker to ensure that everyone is on the same page. 

Once the requirement is clear, the consultant will complete the research and begin the process with the client. A good consultant should be able to discuss the positive and the negative, including the ugly, about the properties that are visited. And in a short time, they should be able to provide values to the properties that have piqued their client’s interest. 

In today’s world it seems that all transactions are much more complicated, molehills become mountains. Therefore, it is important to assemble the right team to navigate a successful path to the finish line.

Why is it important to choose a consultant who specializes in a certain area of real estate?

It’s difficult if not impossible to have extensive knowledge about each type of commercial property (industrial, office and retail), so clients need to choose a commercial real estate consultant who specializes in the specific type of property they’re looking to buy or lease. That’s particularly important in large markets such as Northeast Ohio.

There are many technical differences when it comes to buying or leasing different classes of property. For instance, letters of intent differ depending on the type of property. The typical letter of intent illustrates all the pricing, earnest money, inspection period, what inspections will entail, who’s responsible for what, the closing period, as well as any other business points important to the transaction. That document is negotiable, and ultimately leads to the purchase agreement, so it’s critically important that it’s negotiated by someone who’s knowledgeable.

Once the appropriate solution is identified, the consultant will assist the buyer with and throughout the entire due diligence process. Even in today’s world of instant access to information, good commercial real estate consultants have experience, market knowledge, contacts, networks, etc., that are incredibly valuable to clients. Having a trained professional assisting in the process should provide a for smooth transaction and enhance opportunities for buyers and lessees.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate.

Finding creative uses for abandoned big-box properties

How to reuse big-box-store infrastructure has become an issue for municipalities. As the country’s largest retailers either tumble or pull back from their brick-and-mortar strategies, there’s a belief that more of these properties will be left vacant. 

“Consumer shopping habits are changing the physical retail landscape, and it’s starting to affect many community stakeholders,” says Eliot Kijewski, SIOR, senior vice president at Cushman & Wakefield/CRESCO Real Estate.

He says large retail properties are being abandoned for different concepts. That’s leaving communities with vacant 100,000-square-foot buildings, some of which are two stories, and they’re struggling to find buyers to take the space.

“Today, it’s about helping individual markets understand the possibilities abandoned big-box properties present,” he says. “And stakeholders are doing so by starting with the premise that it’s never going to be another big-box store again, and work from there.”

Smart Business spoke with Kijewski about how to deal with vacant big-box properties and who to engage in the process.

Where should the conversation about repurposing big-box properties start?

Developers are key to the entire process. There are so many businesses looking for land, but there isn’t much of it left to buy. Big-box properties, as opposed to vacant parcels, have assets such as paved concrete or asphalt parking lots, utility connections and lots of acreage. 

Municipal governments should be part of the conversation early on to get a sense of what type of property could benefit the community. They may want to prioritize jobs over housing, or vice versa. With the direction of the municipality, a real estate team can engage with a developer and the process of adapting the vacant property into something that benefits all parties can begin.

What are the pluses of big-box properties?

Many of these former big-box sites are located near highways, which is desirable real estate for just about any commercial property. There’s a lot of potential when there’s a structure that’s in great condition and has highway exposure. That puts the new business in close proximity to a workforce or creates ease of access that makes a commute fairly easy. It just takes a developer with patience to convert such a location, but the upside is incredible.

What role do commercial realtors play in facilitating the reuse of big-box properties?

Commercial realtors serve as the connectors. They can connect municipalities, developers and the owners of the former big-box stores, then facilitate the conversation so that ultimately, the property can be converted from dormant to active. 

Realtors have the benefit of a broader perspective and can be a resource of ideas for potential uses and what stakeholders can do to make it happen. In many cases, it’s a good first phone call to make.

Developers that are looking for properties to revitalize in this tightening real estate market can initiate that conversation, or it can come from the communities — mayors, council people, etc. — looking to finally do something with an empty property.

What should developers and municipalities discuss as they look to make a deal?

Municipalities are concerned primarily with job growth and loss, and how a change in the use of a property can affect the future. A municipality might not want to convert a former big-box plot into something that doesn’t add jobs to the local economy, so converting the building into self-storage might not have much appeal. 

Communities benefit by being developer-friendly. It’s a good idea to instruct someone from economic development to be proactive about reaching out to find opportunities. Also, reach out to neighboring communities to discuss the successes they’ve had repurposing these properties to get ideas. 

As the retail landscape continues to shift, it’s important that municipalities and developers keep an eye out for the opportunities vacant big-box stores create. People in the community are watching these changes as well. Lots of big, empty buildings give them the sense that their community is eroding. But if the infrastructure gets a face-lift and a new, inventive property takes its place, it turns blight into excitement.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate.

Speculative development is on the rise, but competition is heating up

In the Cleveland industrial market, the vacancy rate in the third quarter was 3.9 percent, which historically is the lowest it’s ever been. That’s driving demand for newer, more functional structures, particularly high-bay bulk distribution warehouses, as the economic pendulum continues to swing towards a service-oriented rather than production-oriented market.

Though speculative properties in Cleveland tend to be constructed by homegrown developers, competition in larger markets such as New York and Chicago means Cleveland is getting some attention from national developers.

“We’re getting calls each week from developers that want land for spec buildings,” says George J. Pofok, CCIM, SIOR, senior vice president at Cushman & Wakefield/CRESCO Real Estate. “Out-of-state developers definitely are taking interest in the Northeast Ohio market.”

It’s difficult now to find large tracts of available land in Cuyahoga County, so interest is picking up in tertiary markets such as Summit and Medina counties. That means opportunities abound for developers capable of striking while the iron is hot.

Smart Business spoke with Pofok about speculative development in Cleveland and the surrounding markets.

What is happening to the real estate market as building on spec increases?
Tenants are seeing an increase in occupancy costs. In the past, a tenant could do short term one- to three-year flat deals. But the market has shifted and landlords are getting five- to seven-year deals with 2 percent annual increases.

Costs are also increasing for buyers. A company that recently purchased a property in Parma set a high benchmark for value per square foot, and the building the company left and put on the market came under contract after just three showings.

That’s not to say all buildings sell quickly. It’s really about connecting the right buyer to the right property at the right time.

What effect does an increase in spec-built properties have on lessees?
With the vacancy rate so low, tenants could benefit from a couple million square feet of spec construction because there’s still such a demand for more modern facilities. Developers are building more distribution or light assembly structures.

These buildings range from 125,000 to 250,000 square feet, have 28- to 32-foot ceilings, truck docks in the rear and nominal office space. Companies are often able to take advantage of the cube height, thus reducing their footprint, which helps offset the higher rents for new construction.

Who should capitalize on this trend?
Developers that are aggressive, have cash and can react quickly should act now to take advantage of the current market. There is an element of, ‘if you build it, they will come’ in the market right now. Companies that are aggressive and can move quickly should see a lot of success in this market.

It’s really about getting a shovel in the ground as quickly as possible. Once a property is purchased, developers need to be out there, breaking ground within days or weeks. Developers that have bought land and expect to wait until next spring will be six months behind the curve.

While expediency is important, so is due diligence. Developers also need to complete zoning and environmental work, and have site layout discussions with the municipality. Developers that have experience with that will do well.

There is demand in the market from tenants, and there is investor money looking for deals and a return. Both are relying on developers to initiate the process.

What are the risks?
Timing and location are as critical as building the right product. It doesn’t yet make sense to go out to an extreme tertiary market and put up a 500,000-square-foot spec building. The focus still is in the primary and secondary markets.

There is significant opportunity in the market now. But looking into 2019, though the economy seems to be moving along at a good pace, there is less certainty.

The Cleveland market can easily absorb another couple million square feet of spec properties without a significant impact on the market vacancy rate. But that requires developers to be aggressive, find the right piece of dirt and get to building.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

The case for new construction in a tight manufacturing real estate market

Manufacturing is alive and well, but there are underlying, uncontrollable factors that are affecting this sector.

For instance, despite the lowest unemployment numbers in the U.S. in decades, there are still thousands of manufacturing positions left unfilled and a shortage that is affecting companies’ relocation and expansion considerations.

“The brick-and-mortar aspect of a move will be just about equivalent regardless of location,” says Joseph V. Barna, Principal at Cushman & Wakefield/CRESCO Real Estate. “But there’s no sense in making a significant investment into a facility if your location makes it difficult to attract a workforce capable of getting the necessary production out of it.”

Manufacturing is also being reshaped by ever-advancing technology and shifting trends in logistics. Companies in the manufacturing sector need to understand all the ways in which their facility and its location affect its ability to operate successfully, both today and in the future.

Smart Business spoke with Barna about the ways in which these trends should inform manufacturers’ real estate decisions.

How are these trends affecting the decision between new construction and retrofitting existing buildings?
Northeast Ohio has possibly its lowest industrial vacancy rate in 30 years — about 3.5 percent on average. However, 80 percent of the limited available properties are considered obsolete in that they’re inefficient and can’t be economically retrofitted to meet today’s demands.

Getting what they want means a facility with state-of-the-art amenities and sophisticated, energy-efficient mechanicals. Coupled with municipal or state tax abatements, companies are finding that new construction is the better way to go.

The right work environment is not only necessary for operational efficiency, but also to secure and keep employees. Today’s manufacturing employees don’t want to work in a dark, dirty environment. And because talented, experienced workers are in demand, they can be fickle about their choice of employer.

What should owners who decide to build keep in mind as they design their space?
Think about the future. Buy more land than is currently needed to facilitate expansion. That will also make the property appealing to future users, increasing its future value.

Having additional land available for expansion can also accommodate the changing needs of some users. For example, companies once needed the additional space to stage a number of trucks and trailers. With trends shifting in fulfillment, that land is more often used for employee parking — sometimes thousands of parking spaces. By understanding the trends, a property can be set up to meet future needs.

Construct a facility that’s easy to convert for alternative uses. That likely means a rectangular shape, having ample docks for trucks, a ceiling clearance of 28 to 34 feet and extra land regardless of what’s needed for current operations.

New construction will cost just about the same to put a building up in the middle of the city as it would in a suburban park. To protect the facility’s ongoing appreciation, it’s better to build in a high-demand area that’s more likely to increase in value. Then, when it’s time to sell, the upside appreciation will be significantly better than if it were located in a low-demand area.

Always keep the exit strategy in mind. In addition to the physical structure, features such as good highway access and proximity to the workforce are always desirable.

Why is it important to think about the future when considering a move?
Owners need to understand their company’s long-term growth forecast because what may be a perfect building for today’s needs might not accommodate future growth. Understand the total operating costs of a facility. That’s more than the cost of the brick-and-mortar building. It’s how much it costs to keep it running with new energy-efficient mechanical systems.

Do a thorough analysis before making any move and get consultation from trusted advisers — an attorney, real estate expert, financial adviser or construction provider — because there are many considerations to make. With such a significant investment, even little mistakes can affect the outcome and future value.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

Take the time to understand the language in your lease before you sign it

Due diligence is a crucial step for any business that seeks to make a smooth transition into newly leased space, says Simon Caplan, SIOR, a partner at Cushman & Wakefield/CRESCO Real Estate.

“When you sign a long-term lease, you are now married and committed to that space and the landlord,” Caplan says.

“You need a strong lease agreement to protect both parties and to ensure that everyone understands how certain responsibilities will be managed. The manner in which this process is conducted can go a long way toward achieving this goal.”

Smart Business spoke with Caplan about subtle, but significant issues you should understand before finalizing your next lease.

What key components are included in most building leases?

The most basic element of the lease is the description of the premises, which should include the size; the location in the building if there are multiple tenants; a description of the common area(s); the amount of parking that you receive for your employees, clients who visit your facility and trucks; and the common area factor of the building, if applicable.

It should also be clear who is responsible for the build-out, or any work that is required to convert the space to fit your needs. Besides rent, other potential add-ons to the lease payments could be real estate taxes, building insurance, common area maintenance and cleaning fees, which all should be laid out.

Make sure that all dates are understood such as lease start, rent start, termination, option notice, payments due, etc. These are all common items to include when leasing space and should not be overlooked.

What are some leasing issues that companies commonly forget to address?

One common omission is an adequate description of the condition of the premises that the landlord will be providing for the tenant.

This would include things like new walls, paint, carpet, cleaning, repairs, etc., to differentiate from ‘as-is condition.’
Understand the operating expenses of the property and how they are or may be passed on to the tenant(s). In most leases, the interior maintenance is the responsibility of the tenant while the landlord is responsible for the exterior, structure, roof, parking lot, etc.

Typically the cost of landlord maintenance and repairs are passed through to the tenant, while the landlord is financially responsible for replacement of capital expenses such as a new roof or parking lot.

Sometimes the landlord is permitted to pass through amortized portions of capital expenses.

A good lease provides detail so that both parties understand who is responsible to make what repairs and also who is ultimately responsible to pay for said repairs.

Insure the ability to get and install high-speed Internet, satellite dishes and other high-tech communications systems in the premises and through the common areas, roof, etc.

Understand the damage and destruction clause regarding timing and responsibility if there is a significant fire, flood or other occurrence at the property. The best advice is to include language in the lease that both parties agree to in order to prevent any misunderstandings should the worst occur.

How can you protect against an unresponsive landlord?

If you are constantly having roof leaks and the landlord doesn’t schedule a contractor to fix the leak(s), after a designated period of time, you, the tenant, should be able to call a roofer and have it fixed. The same applies for any other major maintenance or repair issue. A self-help clause gives you the legal ability to potentially apply the cost towards rent or another financial obligation to the landlord. This can only be done if No. 1, the landlord is unresponsive after repeated notifications to address a problem and No. 2, it’s written in the lease that you have the right to do this.

It’s important before you sign your lease that you determine whether your potential landlord is capable of performing all of its obligations. You can be proactive and work with a quality real estate broker who can pass on the experiences of other tenants with different landlords and give you a sense as to whether you might have reason to be concerned before you sign your lease.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

Operational flexibility is helping landlords revive dormant properties

Some area landlords are finding new and better uses for industrial buildings that don’t fit the specifications today’s manufacturers desire. To turn those properties productive again, they’re reimagining them as mixed-use, residential and retail spaces that have the potential to anchor burgeoning neighborhoods.

“Landlords who have a shell of a former industrial-use building that’s been deemed obsolete because the ceiling is too low, the loading areas are too short or the location isn’t ideal are being transformed into multi-use properties,” says Eliot Kijewski, senior vice president at Cushman & Wakefield/CRESCO Real Estate.

He says examples of this change can be seen on the Detroit Shoreway, Midtown and other up-and-coming Cleveland neighborhoods that have shown that repurposing existing properties can create great success for all involved. It doesn’t require rebuilding and there’s no land to pay for, meaning that the application of operational flexibility is economical.

Smart Business spoke with Kijewski about how area landlords can apply operational flexibility to awaken once-dormant properties.

Why is operational flexibility a topic that’s being discussed today?
We’re seeing an ever-changing work environment with emphasis shifting somewhat to tech-oriented companies that need flexibility and a location that caters to what professionals desire. Many of the successfully converted properties are on public transportation routes.

They offer greater use of space per square foot per person, and they can accommodate on-the-go workplaces and shared workspaces that are the trend at the moment.

It’s also influenced in part by communities attracting and adapting to the needs of young professionals who want to live and work in the city. Many of the manufacturing shops in some of these neighborhoods aren’t able to grow to accommodate the needs of companies in this industry and have had to move outside of the city to areas with dedicated industrial zones.

They’re leaving behind old structures that aren’t suitable for the needs of today’s manufacturers, so landlords are taking a cue from the communities and adapting, which benefits everyone involved.

What advantage does it provide to owners?
Operational flexibility enables landlords to adapt to an ever-changing workforce. Offices, light assembly and even commercial kitchens can work within a manufacturing shell and get their businesses off the ground. It’s better than starting from scratch because the bones are there, and any specific requirements of the business typically can be accommodated, such as additional power and Wi-Fi.

How has Cleveland’s commercial real estate market responded to the need for operational flexibility?
There are some landlords and developers who have been able to create a niche by adapting their buildings through operational efficiency to meet changing market demands, and they’ve seen success because of it. It’s easy to look across the market and find those who haven’t adapted.

However, some of the change reflects community zoning laws that haven’t caught up to the trend and now don’t allow landlords to be flexible to meet these new needs.

Industry is also helping to drive change, both in communities and with developers. Cleveland Clinic and Cleveland State University, for example, have helped transform the landscape in their respective communities.

Developers and landlords can look to the very recent past and the recession to see how some recreated themselves, did so for very little money and helped fashion a new landscape. They improved and made viable again buildings they owned, sometimes through public assistance, and became a vehicle for job creation in the process.

Landlords whose properties have stagnated or aren’t winning lease-ups can recover by recreating their property through operational flexibility to make it more attractive and in-demand.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

How to navigate today’s commercial, industrial real estate markets

Commercial and industrial real estate activity has remained very strong with no real end in sight. It has been a landlord/seller market for a while, but now it’s time for tenants/buyers to do their homework and bid aggressively before an attractive opportunity is lost.

“We are continuing to see more and more multiple offers,” says George J. Pofok, CCIM, SIOR, senior vice president for Cushman & Wakefield/CRESCO Real Estate.

“There has even been significant movement in the class C-type buildings that have previously been on the market for an extended time. This is because inventory levels are so low. Companies that need additional space may choose a less-than-ideal building since it is their only option.”

Smart Business spoke with Pofok about how to navigate today’s commercial and industrial real estate market in order to take advantage of available opportunities.

What are the real estate options today for a company looking to grow?
While new construction may cost $60 to $90 per square foot for industrial use, if a company is able to acquire a lesser quality building in the low to mid-$20s per square foot, and spends another $20 per foot to renovate, it’s definitely a savings. With that being said, those types of deals are becoming extremely scarce with recent activity.

What about new construction?
Given the tightness in the market, companies should explore new construction opportunities. While speculative new construction had been dormant during the last economic slowdown, over the past year or so there have been five new speculative construction projects with three additional projects under construction.

The market can even continue to support additional new construction projects.

The cost of new construction might be higher today than it is for existing buildings, but in the long run, companies may save on aspects such as costs for utilities and taxes.

What advantages might a speculative construction project offer?
The speculative product is more for the warehouse/distribution/light assembly type of operation rather than heavy manufacturing, but it is definitely a good option.

Buildings constructed today typically are more energy efficient, have higher ceilings, and more docks and drive-ins compared to those built 10 to 20 years ago.

While the norm in the past may have been an 18-foot ceiling, today’s buildings are being developed with 30 to 32-foot ceilings so companies can rack more product in a smaller footprint. For example, with an 18-foot ceiling, companies may have required 50,000 square feet of space. But if they can take advantage of the higher ceiling/cube height, they can reduce their footprint to 30,000 square feet.

What steps should a company take when exploring existing space?
Companies should do their homework before they get into the market. They need to secure pre-approvals from a lender and have completed their own internal analysis as to their specific facility needs — docks, drive-ins, ceiling height and perhaps a location analysis of employee drive times.

It is extremely important to start early. There is a longer lead time required for manufacturing operations vs. warehouse / distribution operations.

A manufacturing operation has to build inventory so that it can shut down and move equipment before it can ramp up production again, so additional time is needed. But a warehousing operation only needs a short amount of time to relocate racking and product to the new location.

In addition, once a company identifies a building that fits its needs, it should take action. The company can’t wait two or three weeks because that space likely won’t be available long in today’s environment.

How does a company prepare for competitive bidding?
The broker should advise the company that the market is tight and it should be ready to be aggressive with an offer once it has found the space it desires. The offer should also be as clean as possible — free of demands such as an extended due diligence period or a larger-than-typical share of the due diligence costs. A seller might not look favorably on those types of requests, so the fewer strings attached, the better.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate

How to negotiate a sale-leaseback so that both parties benefit

There has been a steady flow of sale-leasebacks in Cleveland as local, regional and national investors find themselves flush with cash, but with limited properties to buy.

“There’s a lot of activity from outsiders looking in,” says Joseph V. Barna, SIOR, a principal at Cushman & Wakefield/CRESCO Real Estate.

The reason, he says, is because it’s so competitive in the major markets.

“If a property becomes available in Los Angeles, Dallas or Houston, there could be 30 investors chasing it who are all capable of writing a check. That’s led investors to look to secondary markets, such as Cleveland, where they’re able to transact at higher capitalization rates with less competition. Cleveland has become a sweet spot because there’s a good mix of opportunity and competition.”

Smart Business spoke with Barna about how sale-leasebacks are being used to satisfy investors’ appetites while offering sellers significant benefits.

What are the conditions that create an ideal situation for a sale-leaseback?
In a sale-leaseback, owners sell their property to an investor while retaining the benefits of using the property, typically on a long-term lease of 10-20 years. The structure is increasingly popular because it allows owners to use the real estate without tying up debt and equity capital.

Companies best positioned to consider a sale-leaseback are those that have a lot of equity in the property and can benefit from freeing that up — for instance, to make an acquisition, pay down debt or as part of an exit strategy.

How do investors determine if a sale-leaseback is a good deal?
For investors, a sale-leaseback is primarily a financial transaction based on cash flow. However, there have been times when a building owner has a 100,000-square-foot property that it leased back for $6.50 per square foot in a market that’s seeing $4.50 per square foot as average.

Investors see that rate and buy at an 8 percent capitalization rate, looking only at the cash flow and failing to take into account the intrinsic value of the real estate. The building owner gets an above market cash influx from the deal, then eventually files for bankruptcy and goes out of business. The investor is now sitting on an empty building and will inevitably take a major financial hit because it takes time to re-tenant at a fair market rate.

Sometimes investors are so eager to push their money out the door that they’ll actually gamble a little on the risk side, increase the capitalization rate and still get burned. Even when the lease is up, tenants often leave and they can’t replace that cash flow because the market is down and the rate was well above market.

Ultimately, the investor needs to understand the intrinsic value of the property, as well as local market conditions before investing.

What should get close attention as the parties structure a sale-leaseback?
A seller will be asked to maximize the property’s value by signing a 10- to 20-year lease. Before doing that, it’s important that they understand their company’s future growth potential, which will determine whether the property will meet the business’s needs for that duration.

Companies that are expecting to grow should plan for an expansion of the physical space. In that case, before making the deal, determine a formula for rent that accounts for the addition. If there is a realistic chance that the business is likely to contract, look into the rights to sublease, or include a cancellation clause as part of lease structure.

Who should companies work with to execute a sale-leaseback?
Logical team members include a trusted real estate consultant with experience in sale-leasebacks, a financial adviser to ensure the projection and assumption are correct, and a legal adviser with a specific focus in real estate.

Investors should also talk with ownership to understand their short- and long-term objectives. These deals can be a benefit to all parties involved, as long as both sides are open and honest about their intentions when negotiating terms.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate