The Cleveland-area real estate market doesn’t have the highs and lows as compared to the national trends, but that’s not to say it hasn’t been slow. Over the past five years, land sales came to a halt, developers stopped speculating new development and new construction became scarce. However, Joseph V. Barna, SIOR, a principal at CRESCO Real Estate, says that a slowly improving economy combined with a shortage of available, functional, existing structures, will spark a need for new development.
“For example, the technology corridor along Euclid Avenue, from East 40th Street to the Cleveland Clinic, has seen a tremendous amount of redevelopment as well as new construction,” he says. “Five or six years ago, when you drove down Euclid Avenue, you’d see a lot of deteriorated vacant buildings. Now you see that many of them are full to capacity, including the new construction.”
Smart Business spoke with Barna about current and future real estate trends and how to find the right opportunities.
What is the state of commercial and industrial real estate in the U.S. and how does it compare with Northeast Ohio’s market?
Over the past five years, the real estate industry has been depressed across the U.S. However, when markets are challenged, many figure out alternative ways of overachieving and new trends emerge. This, combined with a slowly improving economy, has led to an uptick in activity.
Cleveland is viewed as a second- or third-tier market with a declining manufacturing base and not a large distribution hub, so it does not experience the volatility the balance of the industry does. Most industrial users are in the 10,000- to 50,000-square-foot range, within single-tenant or multi-tenant
The industrial vacancy rate in Cleveland is at about 8.3 percent, which is under the national average of 9.3 percent. This is somewhat misleading, as new construction has been shut off and some larger, older inventory demolished. As the economy went south, people bought existing buildings and either expanded or renovated them because the cost was significantly lower than building new. Therefore, the existing inventory is dwindling away. The same is true for the combined blended vacancy between the central business district and suburban office markets, which is at about 12.2 percent, under the national average vacancy rate of 15.2 percent. Again, there’s been very minimal new construction in our office market.
Within the Cleveland area, what areas and types of property are hot?
On the industrial side, the airport area in southwest Cleveland has a very low vacancy rate and is always in demand. Also the I-480/I-77 sector, south of Cleveland, is in high demand, as well as the southeast. In general, in Northeast Ohio, it’s difficult to find well-maintained, functioning manufacturing buildings. There’s also a shortage of high-cube, clean distribution space on the west side of Cleveland.
What will the future of Cleveland’s real estate market look like?
There’s an ongoing need for functional product to accommodate current and future demand. On the sales side, as product diminishes, building values are starting to creep up. Land should also start selling again. There may also be a need for new construction for those requiring specialized buildings. Growth markets will be primarily in specialized manufacturing or a niche-type industry, which can’t be easily reproduced elsewhere because of regional expertise in such manufacturing areas as polymers. The biotech and health care industries are also in a constant state of growth.
As for leasing, there is still a glut of multi-tenant space for users in the 5,000- to 50,000-square-foot range and today’s leasing rates are about 6 percent lower than five years ago. This means pricing will stay flexible for this product type.
How can business owners succeed in this environment?
If you’re a tenant, you’re in the driver’s seat. You can be pretty aggressive on what you want and how you want it because of the amount of available space in that mid-market range. If you’re in an existing lease, start looking at least a year out on the renewal in order to evaluate alternatives. Then, you know what you have to negotiate with while sitting down with your landlord. Because lease values are down, it may be in your best interest — if your location works and your needs aren’t going to change — to go in earlier for a blend-and-extend. You offer to extend your commitment to the property if you can renegotiate your lease rate today. Most landlords welcome the opportunity to secure a tenant for a longer period and will give up a little now instead of losing a tenant down the road.
If you’re a property buyer, you’re going to see a swing toward a seller’s market because of the lack of product, especially if it’s a good, functional building.
Is now the time to buy or lease commercial property?
It’s a good time to do both. If you can find what you need it’s going to cost significantly less than new construction. And while there is still some inventory it’s a good time to ensure you’re not missing an opportunity, because values will increase. In terms of being a tenant, it’s a great time to do your lease deals or re-up early.
Real estate is in a constant state of change. So, be aware of market trends both across the country and locally, and revisit your long-term objectives every couple years. Surround yourself with the right professionals, whether a real estate attorney, contractor, appraiser, banker or real estate broker, to get the most for your expenditures. Whether it’s a good or bad market, there are always positives. You just need to understand your goals and how to take advantage of what’s out there to better position yourself for the future.
Joseph V. Barna, SIOR, is a principal at CRESCO Real Estate. Reach him at (216) 525-1464 or firstname.lastname@example.org.
Insights Real Estate is brought to you by Cresco
There are basic elements of marketing a commercial property that may make it seem simple, such as putting sign in front of the property. However, there are many dimensions to a marketing program that inexperienced sellers might not realize.
“You can’t sell real estate like somebody might sell shoes at Nordstrom,” says Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis. “You can’t create demand. Either people have a need or they don’t, and if they don’t, then there’s nothing you can do about it.”
An owner can be as involved as he or she wants to be in the marketing of a property, and clearly, the more attention paid to detail the better. But by utilizing a broker, an owner will likely get more money on the sale, sell a property faster and be relieved of a lot of stress.
Smart Business spoke with Coyne about what to consider when putting a commercial property on the market.
What are the basic components of marketing a commercial property?
The aspects of marketing a commercial property include a sign in front of the property and postcard mailings that utilize a mailing list that’s well thought out. Sellers should ask their brokers how they arrive at their mailing list. Do they clean them out, use a mailing list service or are they buying a list and throwing postcards out there? Also, make sure that, as an owner, you’re on the mailing list, so every time something goes out, you’re getting a copy.
Other marketing components are print advertising, whether in newspaper or magazines, and online marketing. With a website, you’re getting immediate coverage that extends to the region and across the country. These websites might have virtual tours, one-click scheduling of site tours and an online offer option.
It’s also easy to measure traffic because you can ask a broker how many visitors his or her website gets, how long visitors are staying, where are they coming from and what are they looking at. Also ask your broker about his or her experience in getting people to follow through on their Web visits.
While it is common for people not to have building plans and site plans, it’s a critical component of marketing. When you’re looking to pay million of dollars on a property, you’d like to know the actual size of the building. A broker can get a fire exit drawing of the building, along with other measurements, and send them to a company that will then turn that into a CAD drawing in about a day and at a low cost. Typically these costs are covered by the broker.
What should sellers keep in mind when choosing a broker?
Oftentimes, people will choose a broker based on the broker’s knowledge of a specific market, but they don’t usually look at the person’s process. So before you hire someone who is the king of a small market, see if that person has a proven process. Ask a broker what steps he or she takes when selling a property. You’ll also want references and examples of similar types of properties that person has sold.
It’s critical that the broker marketing the property is there when the property is being shown because he or she might hear someone say, ‘I don’t like this building because it doesn’t have X’ when, in fact, it does. The seller has got to make sure the broker is at every showing.
What elements of a commercial property should be listed?
List as much as you can because you never know what someone is looking for. A good example is a stamping plant that was sold because it’s on bedrock. Who knew that sitting on bedrock would be a selling point? The more you know about a building and the more you can list, the better.
Another thing to consider is that a commercial building always sells better empty. Owners should do as much as they can to clean it, from getting a compressor and cleaning the ceiling to getting a floor scrubber and making the floors shine to painting the walls.
If you want to move the property up in the line of interest, the cleaner the building is, the better. However, that’s something the seller will have to pay for.
Could building owners market and sell a commercial property on their own?
They could, but it’s hard without a broker to buffer emotions. You can say things to a broker that can be then filtered in a way that is unemotional, but if you say it directly to the seller, it could blow a deal up. Brokers understand how to work their way through the emotional part of a transaction.
What are some common mistakes owners make when selling?
One is that they misprice the property. It’s hard to get good, comparable sale information on commercial property. The assets are very different, so it’s hard for someone who’s not in the industry. Go to a commercial appraiser with an MAI designation from the Appraisal Institute and pay for a formal appraisal.
Another mistake is not making it clear whether they’re willing to work with a broker. If they market it themselves and say ‘brokers protected’ or ‘brokers welcome,’ they could get brokers showing up and saying, ‘Hey, I’ve got a buyer.’ But if you’ve mispriced it and you have no clarification on brokers, then you’re wiping out a big part of your market. In the event that a broker approaches the seller with a buyer, the seller signs a commission agreement specific to that buyer.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or email@example.com.
Insights Real Estate is brought to you by Grubb & Ellis
Although bankers sounded a bit more optimistic about the commercial real estate market during the second quarter, more than half of the $1.4 trillion in commercial mortgages coming due nationwide in the next five years are underwater and many banks are refusing to renew the loans.
Owners who purchased property at the peak of the market in 2005 or 2006 face the biggest challenge, because commercial property values have since declined by almost 35 percent. Now, they must refinance to deal with looming balloon payments, but few owners can meet today’s stringent underwriting criteria.
“Roughly 90 percent of commercial mortgages require a balloon payment after five years,” says Vincent Shin, first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. “So owners may need to consider creative financing options to avoid a short sale or foreclosure.”
Smart Business spoke with Shin about refinancing options for commercial mortgage holders.
How has the underwriting criteria changed for commercial property loans?
Prior to 2008, banks considered the underlying equity when evaluating an application for a commercial property loan. Now they’re scrutinizing the underlying cash flow of the business for owner-occupied properties, at a time when many businesses are struggling to turn a profit. In fact, you could say that cash is king. And while bankers used to accept a debt service coverage ratio (DSCR) of 1.0, bankers now want a DSCR of 1.25. To give you an example of the impact, a business owner now needs monthly cash flow of $12,500 instead of $10,000 to qualify for a $10,000 loan payment. Compounding the problem, banks are requiring loan-to-value ratios ranging from 40 percent to 50 percent and high occupancy rates for tenant-occupied buildings.
How can business owners evaluate their situation?
Work with your CPA to determine your debt service ability, so you have a general idea whether you can qualify for a new loan. Do everything possible to boost your company’s cash flow or fill your building with quality tenants by granting temporary rent reductions or improving the property. Then, talk to the current note holder to gauge their appetite for refinancing your existing mortgage. Your current lender will know the state of the marketplace and the approximate value of your property and should help you find a solution to your problem, because the lender has the most to lose if you default or request a short sale.
What are the best refinancing options?
For owner-occupied buildings with outstanding loans of less than $2 million, an SBA loan is your best option. Owners of tenant-occupied buildings should shop around for a deal, because each bank has its own risk tolerance and loan portfolio that influence their desire and willingness to write new mortgages. Drive a hard bargain if your business is flush with cash and use a possible short sale or foreclosure as a bargaining chip to motivate your current lender.
What should owners do if they can’t refinance their commercial property loan?
Beyond a short sale or default, consider these options if you’re facing an upcoming balloon payment.
- Partial principal forgiveness. Some banks may be willing to reduce your loan principal to avoid a short sale or foreclosure.
- Second property. Consider mortgaging another piece of real estate with a lower loan-to-value ratio to pay off or reduce your current loan.
- Offer additional collateral. Sweeten the deal by pledging a second property or offering the bank additional assets or accounts.
- Bifurcated loan. Consider splitting the current loan into two parts and refinancing a smaller primary loan that satisfies the desired loan-to-value ratio. Then, finance the remaining indebtedness under a second deed of trust. For example, if the current property loan is $1.5 million, refinance $1 million through a traditional loan and immediately apply for a secondary loan to secure the remaining $500,000. The secondary loan will probably require a balloon payment down the road.
- Private equity. Refinance through a private equity loan.
- Add partners or investors. Consider bringing in an additional business partner or investor who could provide an injection of cash to reduce the loan principal.
- CRA loan. The Community Reinvestment Act (CRA) was enacted by Congress in 1977 to encourage federally insured banking institutions to help meet the credit needs of their communities, including those of lower-income areas. A building must be owner-occupied to qualify.
Do you have any other tips for business owners facing a balloon payment?
First, start the refinancing process at least six to 12 months before your balloon payment comes due so you can shop the market and improve your company’s cash flow. Use the ramp-up period to clean up your credit report, acquire new customers or tenants or sell an underperforming business unit. Author a business plan, sales forecast and personal profile, because prospective bankers want to see how you intend to pay for the loan. Finally, consider a variety of refinancing options. Owners need to be creative to survive in our current economy.
Vincent Shin is the first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. Reach him at firstname.lastname@example.org or (562) 345-3102.