(Dear Reader: These ‘Business Owner’ segments illustrate how real life commercial real estate challenges can result in win-win solutions…even when the going gets tough!)
Dear Business Owner,
The commercial real estate asset purchased during the downturn is one of your best investments. A reliable tenant, initially produced a healthy, cash on cash, 9 percent annual return on your investment and now it yields a 10.5 percent annual return. Score! Every month there is an automatic deposit into your bank account.
The tenant’s lobby is always packed. The office manager shared that this is their top grossing location in Phoenix. After seven years the lease is about to expire, and new lease terms need to be negotiated with the tenant. It’s time to call to your commercial broker to assess current market rates.
Real Time Market Conditions
I’m driving south on Loop 101 and Lady Gaga’s song, Shallow, is interrupted by an incoming call. It’s Lance, a repeat out-of-state investor client. Lance historically buys an Arizona investment property every two years and it’s time for another. But I’m wrong.
“Andrea, my best tenant won’t be renewing their lease at the Ahwatukee property. They’ve outgrown their space and need to move. What am I going to do?” I hear the click, click of Lance’s cowboy boots against a wooden floor.
Lance briefs me on the details of the tenants need to relocate. We don’t have space for them to expand as the suite next door is occupied by an optical business.
I tap the phone to speaker and fire up Costar, a commercial database. I pinpoint the office condo park and share the following information, “Hmm, surprisingly, rents in that area have gone down. Your current tenant is paying $20 per square foot. A new tenant will expect to pay $15 per square foot. There’s a lot of inventory on the market in Ahwatukee.”
Lance huffs, “The market’s on fire everywhere else. Why not in Ahwatukee?”
Location, Location, Location
“Well, Ahwatukee’s on the outskirts of Phoenix and its population growth has slowed.”
Lance reminds me, “The tenant has six months remaining on their lease, let’s put it up for lease today and secure a tenant ASAP. I don’t want to be sitting on a vacant space that’s costing me money.”
“Would you consider selling the building as an alternative?” I ask, reviewing sales analytics in the vicinity.
“No. I don’t know what to do with the money if I sell the place,” Lance confides. We should all have this problem, I think.
“I’m glad you called me now. Absorption statistics indicate it’ll take six to twelve months to secure a tenant.” We say our goodbyes and I go to work. Lance is a good client and I want the relationship to stay that way.
Five Months Later
Nothing is leasing in Ahwatukee, so I circle back. “Lance, marketing the property for lease isn’t producing results. May I a suggest a new approach?”
“At this point, do I have a choice,” he asks exasperated. A ranch dog barks in the background.
“Now hear me out. Let’s talk about what it looks like to sell the building. Stats show office condos are selling within three to four months. You’ll probably net $30 more a square foot than when you purchased the property. That, along with seven years of rental income and your tax right offs…well, it’s been a fruitful investment.”
“I’ll give it some thought.” Lance mutters. This isn’t his ideal scenario.
I say, “It’s a big decision, but you don’t want to sit on an empty building. If we can’t find a tenant soon, we need to secure a buyer before you start losing equity.”
Lance clears his throat. “Let me talk to my wife and get back to you.”
Timing is Everything
We post the property for sale and the very next day a neighboring tenant inquires.
“Hi, I’m Amanda. I own My Lash across the parking lot. I’ve outgrown my space and the lease expires soon. I found your space online for sale. The floorplan seems to be the right size and close to the configuration I need for my eyelash application business. Is the space for lease?”
Maybe Lance will meet his objective after all: to re-tenant the suite.
My Lash tours the suite with a contractor and they describe their tenant improvement dream list. Inviting a contractor is a clear sign My Lash is serious about a move. As it turns out, the renovation costs more than the tenant can ‘invest’ in the new space. Amanda asks Lance to pay for the tenant improvements. Lance wants Amanda to pay for the improvements. Negotiations are at a standstill.
Before You Can Blink
I visit My Lash with an idea. “Amanda, I understand the renovations are expensive. The landlord won’t pay for them because it’ll be three years before he nets any money from your rent payments. However, I ran some numbers, and if you purchase the office with 10 percent down, your mortgage will be less than what you currently pay for rent.”
“I never thought about purchasing. I’m not sure I want to take my business cash and put it into a building.” Amanda states.
“When you purchase you can roll the renovation costs into the mortgage, your lease rate remains steady without escalations, there are tax benefits and you own the asset building equity over time,” I explain.
“I have no idea how to purchase a commercial building,” Amanda confesses. “What if it consumes too much time away from my business.”
“First of all, you need is good buyer rep to walk you through the purchase process and they can recommend a lender. Phil’s one of the best in town and he won’t cost you a dime.”
Don’t Bat an Eyelash
I recommend Amanda work with Phil, a colleague who will represent her as a buyer. This is a big transaction for Amanda and she needs someone who will represent her interests and walk her through the process. As expected, Phil handholds Amanda throughout the transaction.
Brokers can represent both buyer and seller, known as dual agency, but it’s not always the best arrangement.
The building transfers title to My Lash a month after Lance’s tenant vacated. Happily, Lance made a lot of money. To defer capital gains, he initiates a 1031 tax deferred exchange and purchases another investment property.
Name of the Game
$$$ Tip: Consider purchasing versus leasing to manage your lease rate; often for less than a monthly rent payment. Enjoy pride of ownership and build equity.
Business Owner Tip: Be your own landlord, control your rental rate and enjoy additional tax benefits. Employ the right professionals to get the job done.
- Lance ended up with a 30% return on his initial investment before taxes.
- To save on capital gains, Lance purchased another income producing asset under a 1031 tax deferred exchange program.
- The buyer custom designed the interior of the new space and moved her business across the parking lot. The mortgage rate was less then her past rent.