Whether to buy or lease is a question real estate professionals hear from business owners all the time. It’s a difficult decision that’s based on several factors.
You should evaluate your needs, as well as your personal and business goals, with a qualified real estate consultant, says Joseph V. Barna, SIOR, principal at CRESCO Real Estate. Also, understand your motivation drivers — are you interested in the bottom-line cost of occupancy, long-term ownership, image or flexibility?
“You need to step back and look at where you’re at, where you want to go, and how important your personal goals on the ownership side are in order to understand the best manner in which to invest your money,” he says.
Smart Business spoke with Barna about what propels owners to buy or lease.
What drives owners to buy?
One example would be if you are in a specialized industry and you’re going to make a significant investment in the space’s infrastructure. You don’t want to be unable to come to terms on a down-the-road lease renewal or expansion and have to reinvest in another building.
Another scenario is that you don’t anticipate long-term future growth and the facility you identify is in a desirable location that meets your projected needs.
Many times, the deciding factor is whether you can buy a building, ‘right.’ If a building can be acquired in the lower range or below market value and/or combined with market-driven incentives, the opportunity is worth serious consideration.
Sometimes it comes back to pride of ownership. In Northeast Ohio, we are fortunate to have a wealth of successful entrepreneurs who want to own their real estate simply for pride or a desired image, even if they have to pay a premium for it.
Why do business owners decide to lease?
One reason would be that your space requirements could fluctuate, so you don’t want to be locked into a building. Often this can be market driven; your business grows when the market’s healthy and contracts when it’s not. Also, many large national or global companies lease space because they don’t want to be in the real estate business and worry about selling a property when they decide to relocate.
You also should look at the return on investment. In real estate, a typical return for a market transaction would be 8 to 13 percent on the property’s value. However, if you have a dynamic business that’s getting a 25 to 30 percent margin on your products, it may be better to put your cash into increasing manufacturing and market share for the higher ROI. In addition, our financial markets have changed over the past five years. In most cases, traditional real estate financing has higher equity requirements, such as 25 to 35 percent down, which could also be a deal killer.
How can a lease-purchase analysis help?
To determine the actual cost of occupancy, bring in a qualified broker or consultant to run a lease versus purchase analysis. On the lease side, you look at your base lease rate, utilities, pass throughs and any other additional costs. On the sale side, you’re weighing your equity requirement, mortgage payment, property upkeep, maintenance, insurance and taxes. The analysis gives you a clear-cut idea of whether you’re better off leasing or buying.
The final decision will not always be the lowest cost alternative, but this analysis will at least let you know where you stand based on the cost of occupancy. Then you can consider other factors, like proximity to your customer base as well as employees, flexibility and personal objectives.
How far out should you start considering whether to lease or buy?
The perfect situation is at least one-and-a-half to two years ahead of when you need to make a decision. You need to understand the current market trends, all of the logical lease and sale alternates and the price of new construction, while projecting where your business will be in five or 10 years combined with personal objectives. You can go into the market and identify the perfect alternative, but it could take a year to consummate a transaction — and even more time if you’re building new, retrofitting or applying for government incentives. If you let that fuse get too short, it limits your alternatives.
Joseph V. Barna, SIOR, is a principal at CRESCO Real Estate. Reach him at (216) 525-1464 or firstname.lastname@example.org.
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When manufacturing companies are looking for a new or additional location, they’re often concerned with the availability of quality labor, utility costs, freeway and rail accessibility, local and state taxes, and building availability and costs.
While these are all important considerations, there are some things to look at that might not be as apparent, which is why working with an experienced commercial real estate broker can help.
“Brokers will talk with members of the business community from similar industries to give their client a more three-dimensional picture of what it’s like doing business in the area,” says George J. Pofok, CCIM, SIOR, senior vice president of CRESCO Real Estate. “They’ll also connect with their area colleagues who live and work in those markets to give company executives both the 30,000-foot and on-the-ground views.”
Smart Business spoke with Pofok about conducting a nationwide site search and how brokers can help companies dig deeper.
What might be the biggest hurdle in conducting a national site search?
It can be difficult to get quality and timely data on building availability from existing databases. When casting a search that wide, it’s important to talk with state economic development groups in addition to searching the national databases such as CoStar and LoopNet. Commercial real estate brokers also can help companies in their search by tapping into the Society of Industrial and Office Realtors (SIOR) professional network to solicit potential sites that suit a client’s needs.
However, relying on listings is precarious. Properties as advertised are not always what they seem. Once properties of interest have been identified, phone calls should be made to all the listing agents to start verifying accuracy and solicit property brochures, photographs, floor plans and site plans.
How much weight should a company give to economic incentives?
Economic incentives can be extremely beneficial, but they often come with strings attached. Sometimes to get the benefit of an incentive a company needs to meet certain hiring requirements or pay a certain wage. But if the company fails to do so, which can be the result of factors outside of the company’s control, there can be clawback provisions.
Incentives are helpful but shouldn’t be the key driver for a decision to move. They should be weighed against other factors such as the state or county’s environmental regulations, corporate income tax and municipal tax rates. But all things being equal, incentives can tip the scales.
How can commercial real estate brokers help companies choose a site?
Many brokers come from full-service firms with coverage in most major markets, both nationally and globally. They can help tenants and/or buyers with site acquisition, incentive and location analysis, and often partner with their consulting arm to perform a network rationalization study, which allows companies to compare regions to determine the impact each would have on the different aspects of their businesses and end users.
Further, brokers can work closely with key individuals in federal, state and local government to vet initial search findings and see how each agency might be able to work with the incoming company. Being on the ground also allows a broker to determine if the local quality of life suits the business. They’ll look at housing values, the retail areas and other local amenities to give CEOs a good sense of the community they could soon become a part of.
What are some important qualities of the agent who helps conduct the search?
Look for a broker who has experience. If an agent hasn’t completed similar deals he or she won’t know the right questions to ask. Also, a broad network is key, in regards to both the firm he or she represents as well as his or her professional network. An affiliation with groups such as SIOR and the Certified Commercial Investment Member Institute (CCIM) provides a network of top-producing real estate professionals throughout the country. Ultimately, you need a broker who is diligent, works hard to earn your business, and is timely and responsive.
George J. Pofok, CCIM, SIOR, is senior vice president at CRESCO Real Estate. Reach him at (216) 525-1469 or email@example.com.
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Until the middle of 2011, northeast Ohio was a tenant’s market. However, with real estate growth, free rent incentives and large price drops going away, the market is starting to lean more toward landlords, says Eliot Kijewski, SIOR, senior vice president at CRESCO Real Estate.
“I can’t tell you how many times we get a phone call saying, ‘I need to be in something in 30 to 60 days,’” Kijewski says. “That’s not enough time when you’ve still got to negotiate a lease and the landlord generally has work to do in the space.
“You need to be in front of it. You can make your best deal that way,” he says.
Smart Business spoke with Kijewski about how business owners can maximize the value of their renewal or relocation.
What should you consider when deciding whether to renew your lease or relocate?
First, reread your lease to find out what your timing should be. You need to know the option date, if one exists, in your existing lease. It’s most likely six months, but in some cases it could be 60 or 120 days. For instance, if you’re coming to the end of a five-year lease and you have to notify the landlord whether you’re going to stay six months from the lease-end date, you’d better see what else is out there — check out pricing and deals, the size and efficiency of available space, etc. You want to be in the market at least four months ahead of your option date.
Ninety percent of landlords are still going to do whatever they can to keep a tenant, such as throw in tenant improvements or be flexible on the rate. The difference is that, as the market tightens up, landlords are starting to look at the option date because they may have been giving deals away a few years ago, but now they could get another tenant in for more money.
How should you weigh your existing space against the available space?
With the help of your broker, there are a number of questions to ask that take into account your long-term goals. Is your existing space too big, too small, not heated properly or not meeting your technology needs? Did your business model change? Are you comfortable here?
It’s imperative to actually check out the market. For example, if you move one city over, your taxes could be dramatically less.
A tenant representative can generate data to help you feel confident about staying or leaving by looking at employees, governmental incentives, etc. Employees really care about where their workplace is located; so if you move to the best deal, you might lose employees.
How can business owners account for the costs?
Remember that it costs a lot of money to move — no matter what business it is. You have to pay a mover, or do it yourself, which doesn’t allow you to do your work. Then, you’ll need new stationary printed, websites and phones updated, etc. Based on what type of tenant you are — industrial, office or retail — your broker can assist with estimating these types of costs.
At the same time, it costs the landlord as well, which gives tenants leverage. If the space goes ‘dark’ or vacant, the landlord has to prepare the space with cleaning and/or renovations, promote the space and hire a broker.
What’s important to know about the negotiations?
A lease is a huge commitment. For example, if you’re coming to the end of your term, you may have a clause that says you have to renew for a certain amount of time. But, if you’re uncomfortable, don’t let your company become a captive tenant. This can be negotiated with your landlord with the help of your broker.
Your broker is critical to informing you of the various circumstances with the existing landlord and the surrounding market. He or she also can help with timing the negotiations correctly. You want to start that conversation with the landlord close to the option date, but not close enough that it jeopardizes your leverage.
Eliot Kijewski, SIOR, is senior vice president at CRESCO Real Estate. Reach him at (216) 525-1487 or firstname.lastname@example.org.
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After signing a contract for your commercial building purchase, you begin due diligence, which is usually a 45- to 60-day period you and your broker use to inspect every possible issue, use or aspect of the property. There are a number of key areas to consider and you only have a limited time to do so.
“Next to negotiating the purchase price, the due diligence period is probably the most important part of the transaction from the buyer side,” says Simon Caplan, SIOR, principal at CRESCO Real Estate.
Smart Business spoke with Caplan about the critical points to check — or re-check — during the due diligence period.
Who do you check with about property use and government concerns?
Every community has different zoning codes and definitions vary from city to city. It’s imperative to check with the mayor or local zoning official that your planned use of the property fits within the current zoning and to ascertain what you need to do to get all required occupancy permits to operate your business. This would include building permits if major renovations or an addition are part of either your short- or long-term plans. It’s also important to ensure your building will pass fire and building inspections. In addition, some cities require a point of sale inspection; for the most part, these are the inner ring suburbs bordering the city of Cleveland such as Bedford and Garfield Heights.
Usually the availability of a tax abatement, income tax credits or other economic incentives are mentioned in the purchase agreement. However, the due diligence period is most likely when the incentives are actually granted.
What are some best practices to follow with the title?
Review your property’s title commitment to find problem areas that could include liens, deed restrictions, easements, mineral rights, etc. Make sure you understand your rights. For example, property easements may benefit you or may hinder your use. Know who is responsible for repairs and how they relate to planned expansion. Some issues, which you may already be aware of, need to be discussed with the title company and/or seller and should be removed from the title insurance policy. Ninety-nine percent of the time you want to get an owner’s fee policy.
What should be surveyed?
The best survey is an American Land Title Association (ALTA) survey, which lets you know what you are buying. An ALTA survey shows property lines, exterior building lines, paving, curbing, catch basins, parking, fencing, utilities, landscaping, etc., as well as easements or encroachments. The title commitment only gives easements in hard-to-understand legal terms. On an ALTA you can actually see how they affect property. Other areas to study are parking, expandability and storm drainage.
How should building owners assess environmental factors?
When buying commercial property, even if everything appears clean, you should have an environmental Phase I study done. Phase I is a historical assessment and a physical walkthrough of the property by a certified environmental consultant.
If Phase I recommends further inspection, you move on to Phase II, which involves taking samples of soil, ground water, concrete, potential asbestos-containing materials or other suspicious environmental conditions. Phase III is the actual cleanup, which can be costly. Environmental factors are one of the biggest deal killers and lengtheners.
What's critical regarding the building?
The building inspection is essential, parts of which can may be taken into account earlier. The major issues are the condition and life expectancy of the roof system; the structural components of the building, especially walls and floor; and that the mechanicals — fire suppression sprinkler, HVAC, plumbing, electrical — are working and to code. These relate to the building’s integrity and can be expensive to fix.
What if there are many problems?
If problems or obstacles are discovered that have serious economic impact or use impact on the property, you should walk away from the deal or get the seller to renegotiate the purchase price.
Simon Caplan, SIOR, is a principal at CRESCO Real Estate. Reach him at (216) 525-1472 or email@example.com.
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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.
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Recently, a company with 55 locations — a good solid credit tenant — was looking for space in Northeast Ohio. There were three potential locations, and in two of the cases, the landlord was not willing to spend money on tenant improvements. Therefore, the owner of the third property got the deal.
“Oftentimes, we see tenants and landlords butting heads on improvements, but really, at the end of the day, most deals get done with some sort of compromise between the parties,” says George J. Pofok, CCIM, SIOR, senior vice president at CRESCO Real Estate. “On the other hand, there also are times when landlords or tenants will kill the deal and decide financially it’s not worth pursuing.”
Smart Business spoke with Pofok about how tenant improvements are used as a negotiating tool for both landlords and tenants.
What types of tenant improvements are typically made and why?
From an industrial perspective, the typical tenant improvements are the movement of a wall or two or replacing paint and carpet, as these are things landlords have been conditioned to take care of. A couple of other considerations could be replacing any stained or damaged ceiling tiles and making sure all mechanicals are delivered in good working order. These kinds of improvements are usually done because they are low-cost items that are easy to complete and make a big impact. For instance, if you have a manufacturing operation, oftentimes guys in the shop walk over the carpet with their oily boots, which tends to wear it out quicker than it really should.
What is the difference between capital and tenant improvements?
Capital improvements are similar in nature to tenant improvements but usually are bigger building-type improvements such as replacing a roof, repaving a parking lot, or upgrading the heating and air conditioning system. Tenant improvements are often made to the interior and are more cosmetic. For example, there may be 10 private offices and the tenant moving in may only need five and an open bullpen area. An energy efficiency improvement might be replacing lighting fixtures, but if you’re going to waterless urinals, as an example, those are more capital intensive and it’s an added asset, in most people’s eyes, for the building rather than the tenant.
How should tenants negotiate to ensure the best rates on industrial leases?
If you’re an existing tenant, you have more flexibility because you have a past history with the landlord. Since being there, the roof is that much older, the parking lot is that much older and that means more leverage. When you’re a new tenant coming in, there’s less flexibility, especially for capital-intensive improvements. This, however, can depend on the credit of the tenants; obviously if you’re a Fortune 100 company the landlord knows your check is going to be good.
As a tenant, you should:
- Start the process early on. When you’re touring a property, take careful note of what the space looks like and have all your needs ready upfront first versus having to go back to a landlord again and again.
- Prioritize so you know what you’re willing to give up. For example, you might want carpet changed in all the offices, to add a couple of additional private offices and have the warehouse painted white. Maybe painting the warehouse isn’t as critical to you, but the other two items are; then one of them can be a gift back to the landlord to get what you really want.
- Know cost estimates of what you’re requesting. If you’re going to ask for too much, then the landlord may take a tougher stance from the very get-go.
Another tenant tool is to pay for improvement expenses upfront and have the landlord amortize it via free rent or reduce the base rent.
It’s important to be fair and reasonable as you’re negotiating because landlords want to feel that they get a victory. It can be something small, but as long as they feel like they won part of the battle, then they will be more receptive to working with you.
How are the current economy and market influencing negotiations?
With landlords still hungry for tenants, they want to show to their lender a higher base rate but could still spend money to keep the tenant happy with free rent or additional dollars for miscellaneous improvements. Therefore, if your landlord wants to keep a higher base rate, you can typically ask for more improvements.
Despite this, tenants need to be aware of how the market is starting to change. As manufacturing took a hit over the past few years, landlords needed to be creative to backfill spaces that hit the market as a result of the recession. Now, the market is getting to a point where it has recovered and certain product types are more difficult to find. It’s been a tenant market, but now it’s just as favorable to the landlord.
The vacancy rate has decreased significantly. Right now, it is hovering around 8.3 percent, which is extremely healthy for the overall Northeast Ohio/Cleveland market. A year ago, the vacancy rate was 9.6 percent.
Leasing rates are not changing yet. Historically, they have remained very stable and consistent. The hope is as the vacancy rate declines, property owners will start seeing a slight increase in the flat values. This situation is semi-unique to the Cleveland market. When everyone had the big boom, our boom in the Cleveland market wasn’t significant so we don’t have as far to fall. The base rates are within 5 to 10 cents of where they have been over past five years.
George J. Pofok, CCIM, SIOR, is a senior vice president at CRESCO Real Estate. Reach him at (216) 525-1469 or email@example.com.
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When purchasing property, there are a lot of details to track. Failing to hire an experienced real estate broker could cost you both time and money if just one of those details is overlooked, says Eliot Kijewski, a sales associate at CRESCO Real Estate. “By following a purchase agreement abstract, the buyer can help ensure that proper due diligence is done and that there aren’t any surprises after the deal has closed,” says Kijewski. Smart Business spoke with Kijewski about how an experienced real estate broker can help you avoid costly mistakes. What is the first step when considering purchasing property? A purchase agreement abstract provides a checklist of steps to follow. It breaks down the purchase process for both the buyer and the seller and ensures everything is done properly. Following this, the first step is for the potential buyer to provide earnest money to a quality title company. In addition, almost any transaction of more than $350,000 requires an environmental policy assessment. However, if it is a known hazard area, such as a gas station or a site that is otherwise suspect, that assessment will be required. In Phase 1 of the assessment, which costs $2,000 to $5,000 and averages three weeks, the history of the property and all its known prior uses are examined. If the buyer is going through a lender, this phase may not be optional, even with a low purchase price, as the lender will almost always require it. If Phase 1 comes back with suspect information — for example, if the site had heavy industrial use or hazardous chemicals have been used on site — there will be a Phase 2. Further testing will be conducted and samples are sent to a lab. This phase generally starts at about $9,000 and can become really expensive, and it averages six weeks. Neither side may want to pay for the study, but it’s critical to provide the buyer and the seller with peace of mind about the transaction. In some cases, the potential buyer and seller may choose to share the cost. If Phase 2 comes back inconclusive and the transaction is called off, each side has lost just a little, versus the entire cost of the purchase. How can surveys help ensure buyers know what they are getting? Surveys are an important tool used to identify the boundaries of a property and can be general and inexpensive. However, an American Land and Title Association survey can provide more in-depth information should you want to know more about what you are buying. An ALTA survey is very detailed and shows you exactly what you are purchasing, such as the utilities, the topography, etc. Having this survey done is always a good idea, but it can be very expensive depending on the size of the property and the complexity. Another advantage is that you may understand the potential of existing wetlands. What are the next steps? Hire a trained professional to do a building inspection. That person will check its structural soundness, the HVAC system, the roof and electrical system mechanicals. Also have the IT system inspected to gain an understanding of its capacity. At this stage, you should also arrange for phone and IT services because those can take a long time to install. If the sale doesn’t go through, you can cancel it. Also ask about warranties on the roof, the HVAC system and other items for which a warranty may transfer from the buyer to the seller, and find out how much time is left on those to understand potential future costs. How can incentives and zoning affect a sale? Check with the municipality to see if anything is available to help you with financing or if there are incentives that can make it a more attractive purchase. Also talk with the state and county to see if there is anything they can offer to sweeten the deal. You should also check the zoning to ensure that your intended use of the property is acceptable. If you’re going to need a variance, you need to know about it before you commit to the purchase. What does a potential purchaser need to understand about financing? Assuming that you are financeable, check with your lender to see how quickly it can complete the transaction. Otherwise you might find yourself in a situation in which the due diligence is done and you’re ready to move forward, but the bank can’t finance for another four weeks. Also consult with a broker to see who’s doing deals, as banks have SBA programs that can help. With these loans, the government accepts a large part of the responsibility for the project, allowing you to lock in rates. These loans are not the easiest to obtain, but they can provide a huge benefit. Once you have completed all of the steps, it’s time to close the deal and determine when everything will be in place so you can move in. Is this process something the average business owner can accomplish on his or her own? No. You definitely need help. Even experienced building owners still hire brokers, attorneys and other professionals to help them through the process. If you try to do it yourself, you will overlook some of these critical steps because you’re not used to doing them on a daily basis. Your broker can keep things moving along and hold the deal together. Eliot Kijewski is a sales associate at CRESCO Real Estate. Reach him at (216) 906-2414 or firstname.lastname@example.org. Insights Real Estate is brought to you by CRESCO Real Estate
You’ve found the perfect office or commercial space and you’re ready to commit to a lease. But before you do so, you need to be aware of potential issues so that you don’t make costly mistakes, says Simon Caplan, SIOR, a partner with CRESCO Real Estate. “By the time the tenant and landlord start negotiating a lease, they’ve already agreed to the major lease points, such as what the rent is, the space buildout plan, the amount of tenant improvement dollars, etc.,” says Caplan. “Once you’ve got those together, you’re ready to negotiate the lease, but you need the help of an expert in order to avoid potential red flags.” Smart Business spoke with Caplan about some common red flags for tenants to look out for and issues you need to raise for your own protection. What are the major issues to be aware of in a lease? The normal process for a potential tenant is that you hire a broker to show you the best spaces for your requirements, then you look at spaces and you choose the best space for your needs. From a tenant perspective, you want to know how big the space is and how much you are going to pay and for how long of a term. What is the buildout going to look like? What are the tenant improvement dollars? Is there a period of free rent? Once you have negotiated those major points, the next step is to start negotiating the lease. What are some common red flag issues to look out for? One of the biggest areas tenants should be aware of are pass-throughs, that is what costs the landlord is allowed to pass through to the tenant. Based on that, when the landlord is doing a buildout for the tenant, if it is extensive, the tenant should have the ability to monitor the landlord’s contractors to make sure the work is of good quality. It should be specified in the contract that the tenant is allowed to observe/inspect the landlord’s work When you rent space, the landlord is usually willing to give a tenant a one-year warranty on the space. Then, after a year, the tenant is responsible for all in-suite maintenance. So if the buildout is not done right – or if the existing space is not in good condition – you don’t want to be stuck with a problem down the road. You really need to know what you’re getting into and who is financially responsible for what. Also regarding maintenance, the tenant should agree to maintain the space and do minor repairs and attempt to get the landlord to do major repairs and replacements. This issue needs to be explicitly addressed as to who is responsible for what in areas including roof repairs, the parking lot and common areas. In most leases, the tenant pays for repairs and the landlord pays for replacements, but you need to spell that out. In addition, the tenant should ask for the right to audit common area maintenance reimbursements once a year. At the beginning of every new year, the landlord should have figured out all of the costs for the previous year and submits them to the tenant to justify what the tenant has to reimburse. If the tenant thinks the numbers are high, that right to audit would then allow the tenant to inspect the landlord’s records to make sure that what the landlord is billing them is correct. Are there any issues that tenants should raise for their own protection? If the tenant has a problem such as a leaking roof, there is nothing worse than an unresponsive landlord. To protect yourself, you should try to include a self-help clause. That way, if you repeatedly have to call the landlord to fix things and the landlord doesn’t take care of it, you have the right to take care of the problem yourself, pay for it yourself and then bill the landlord or subtract it from the rent. You will have to give the landlord proper notice, but if the landlord is not responding, you can notify him that if he doesn’t take care of it by a certain date, you’ll do it yourself. In addition, every lease has a ‘Damage and Destruction’ clause. If there is a fire, or major storm damage, what are you going to do? How long will you give the landlord to put the space back together for you? And what will you do in the meantime? What you want to pay attention to is how long will you give the landlord to put the space back together for you. The goal is to get the landlord to fix the building as quickly as possible. But it takes time and, as a tenant, you have zero control over that. The Damage and Destruction clause gives the landlord a certain amount of time to do the work, and if it’s done within that time, you have an obligation to come back to the space when it’s ready. Make sure you have Business Interruption Insurance. Also, for your own protection, include an option to extend the lease. Normally there will be some type of increase in rent, sometimes tied to the Consumer Price Index. This gives you the guaranteed right to stay in the space for an extended term at this agreed-to price. You still have the option to try to negotiate a better rate at the extension time. Finally, ensure that you have the ability to install high-speed Internet, satellite dishes and other high-tech communication systems through common areas such as roofs, halls, etc., to get into your space. Tenants often make the mistake of assuming they’ll have access, but the landlord doesn’t have to grant you access. How important is it to have an outside adviser review a contract or lease before signing? You absolutely need a professional to work with you through the process. With a lease, the tenant, the broker and the lawyer should all go over the lease individually and make comments on different clauses, then compare notes before responding back to the landlord. Landlords expect tenants to make reasonable changes to the lease terms, and when you’re leasing office or industrial space, just about every clause is negotiable. There are many other issues that your professional can advise you on to help save you future grief. Simon Caplan, SIOR, is a partner with CRESCO Real Estate. Reach him at (216) 525-1472 or email@example.com. Insights Real Estate is brought to you by CRESCO Real Estate.
Investing in real estate may seem like a simple proposition. You find a property, buy it, make improvements and then lease or sell it for a profit.
But going about it the wrong way greatly increases your chances of owning a property that costs you far more time and money than you planned on, says Joseph V. Barna, SIOR, principal, CRESCO Real Estate.
“The key is to start with a good investment model and an understanding of what you can do, what you can afford, what is realistic and what you’re capable of accomplishing,” says Barna. “Then you find something that fits. Once you think you have it, go back and make sure your research is correct as it relates to the specific investment. What do you think you can rent it for? What do you think the property can sell for? What are the trends and needs in that particular market? You have to anticipate the worst and plan for it, and if your numbers still come out, you’re probably going to be OK.”
Smart Business spoke with Barna about how to avoid rookie mistakes when investing in real estate.
Where do you begin when looking to invest in real estate?
First, you need to have a well-thought-out plan. In most cases, a poor plan, or lack of a plan, is the biggest mistake first-time investors make. The key is to choose an investment model that works for your financial position and comfort level, then identify a property that is well aligned with your model.
Most people do the opposite. Rookie investors will find what they think is a good deal and then try to develop an investment plan to make that work. But that’s where the trouble starts. You need to put together a business plan and then find something that suits that plan, not just stumble into what you think is a good deal and then grab at straws to put it together.
What are some mistakes first-time investors make?
A common mistake is failing to have an exit strategy, which is just as important as having a plan when you go into an investment. Rookie investors will have one investment strategy, perhaps even a pro forma, then assume that investment is going to perform as it’s laid out based on what they think is going to happen.
An experienced investor, however, will have an investment pro forma and run the worst-case scenario and look at the downside, then run the best-case scenario and look at the upside. You have to plan an exit strategy for multiple situations or you can get burned.
How important is doing research on a potential real estate purchase?
It is extremely important. Real estate is local and each submarket within a specific market is different. It’s crucial to understand local market conditions, the specific submarkets within a market as well as the cycles and trends within those sub-markets, because what was a hot area two years ago could be cooling off today.
What role does due diligence play in determining whether to make an investment?
When people think of due diligence, they commonly focus on the physical structure, the condition of the roof, the mechanical systems and the environment condition of the property, but it goes far beyond that.
For example, if you buy a multi-tenant building in a healthy market in which the rents are at the extreme high end, you’ll get a great return, so you may think that’s well and good. But that property may have a tax abatement in place that will end in three years, and when it does, increased property taxes are going to kick in. That can add considerably to your operating expenses. All of a sudden what you thought was a good return isn’t, and because tenants don’t want to pay an above-market rate, you start losing them when you attempt to pass through the increase.
Zoning is another consideration. Meet with the city before the purchase, because your intended use may not be quite in line with the zoning requirements. If you don’t, you’re going to spend extra time and money trying to get variances, and the cost of that may offset the logic of buying that property.
How can bad math cause problems?
Inexperienced buyers may think it’s easy to buy a property, improve it and either lease or sell it. But they often underestimate the time and money it takes to improve the property as well as the time it takes to find a buyer or tenant. If you think you’ll have to hold it for six months and it’s actually 12, then you’re paying a mortgage with no cash flow coming in.
If you think you are going to buy a building, then flip it for a profit or lease it, double the amount you think it’s going to take to improve it, double the carrying costs as well as the time you think it’s going to take to sell or lease, and if the numbers still make sense, you might have a good deal.
Another mistake regarding money is overleveraging a property and failing to leave enough room to carry the property. If you can’t lease it or sell it, you still have to pay the mortgage, insure it, pay property taxes, heat the property and market it. All of a sudden, that great deal is not so great because you didn’t compensate for the downside.
How important is having advisers?
You need to surround yourself with trusted advisers, including a real estate broker, banker, real estate attorney, accountant, contractor and perhaps a mentor. If you do that and do your homework, you’re much better off than going in with your eyes shut and you increase your chances of success.
Joseph V. Barna, SIOR, is a principal at CRESCO Real Estate. Reach him at (216) 525-1464 or firstname.lastname@example.org.
With a plethora of real estate signs posted around town, it may seem like a simple task to go out and find a new location for your business.
But it’s not that easy. And businesses that do not start planning 12 to 18 months out may find themselves forced into an unsuitable space or paying more than they would have if they had planned ahead, says George J. Pofok, CCIM, SIOR, senior vice president of CRESCO Real Estate.
“Very often, businesses wait until the last minute to start looking because they are focused on growing the business and real estate falls into that, ‘We’ll get to it when we get to it’ category,” says Pofok.
Smart Business spoke with Pofok about how early planning can increase your odds of a successful business move.
How early should a business start thinking about a new location when considering a move?
If you’re in a lease situation, you want to start looking 12 to 18 months ahead of the expiration of your lease agreement. Part of that depends on the size and type of company; larger companies and specialty niche type companies typically need to be even further ahead, and if you are a smaller manufacturer or office user that occupies 3,000 to 5,000 square feet, you can probably get away with nine to 12 months.
The process may take even longer for new construction, which will involve land acquisition, building design and multiple layers of financing, as well as dealing with the state, county and municipality about building permits, economic incentive and low interest loans. Because you’re dealing with government entities, things tend to progress more slowly than they would in private enterprise.
What should a business be looking for in a new location?
You need to have projections on where you see the growth of the company, both in terms of sales and in where your industry is heading. I would also encourage you to talk with your employees and see how their current space functions, because oftentimes, managers are not in tune with the product flow or distribution flow. For example, in the distribution sector, the people who are driving the tow motors and delivery vehicles on a daily basis may be able to offer valuable suggestions on how to set up your warehouse and eliminate some of the redundancies and improve company logistics.
What do you need to consider regarding location?
As you’re looking at moving, you need to take into account your employees and where they live. Are you currently centrally located? Are you drawing a mix of people from the east side and the west side? Companies are often concerned that if they move from the east side to the west side that they are going to lose valuable employees who live on the east side.
You also want to look at the location of your customer base. If you are a warehouse distribution company, where are you sending your products? You want to be as close as possible to a prominent freeway so that you can eliminate the downtime of your drivers going to and from your building to the freeway. If you are looking at a location that is 20 minutes from the nearest freeway, you have 20 minutes to your building and 20 minutes back, leaving your drivers to spend valuable time just commuting to the freeway.
And if your drivers are earning $20 to $25 an hour, adding that up on a daily basis can contribute significantly to your bottom line.
How can starting the search early help your negotiating power?
If you wait too long, you can be forced into a making a bad decision. It hurts your leverage and negotiating power with an owner or landlord. This typically happens when a company’s lease is expiring or already has expired, and has waited too long to start its search.
If a landlord knows that you need to make a decision, they can stick to their numbers because they know you need to make a move and make a decision now. But if you’re planning things out, you can negotiate and lay out your needs a little better, and focus more on finding a location that is really geared toward what you need in your business.
How can an outside expert assist you?
Searching for a new location requires a combination of internal and external expertise. Nobody knows your business better than you, so it is imperative for you to gather information to provide an internal perspective and share that information with the external service provider. This is a team effort. Making the right real estate move will help the future direction of the company.
The external provider should ask the right questions to help pinpoint your needs. Are you currently feeling any pain? Is there something in your current space that doesn’t work for you? For example, are you currently in a 14-foot clear building that prohibits you from keeping additional inventory on hand because you don’t have the space? If you move to an 18-foot clear building, can you rack higher and have additional inventory on hand so that your customers don’t have to potentially wait for a delivery?
It’s really the job of the service provider to set and manage expectations. For example, a business may have a 40,000-square-foot building, however, it has low ceilings and multiple demising walls separating the manufacturing or warehouse area. Today, this is typically an inefficient way to operate. Many companies still have it in their minds that they occupy 40,000 square feet and that is what they need. But when the external provider takes them into market and shows them a wide-open 40,000 square foot space, it makes them rethink whether they actually need that much space. It is critical to consider all the efficiencies and inefficiencies of a building.
George J. Pofok, CCIM, SIOR, is senior vice president of CRESCO Real Estate. Reach him at email@example.com or (216) 525-1469.