CEO's can benefit from the current downturn in commercial real estate as prices drop.

Jerry Lehman
CEO, president and principal broker
Prudential CRES Commercial Real Estate SFL

How long the downturn in the commercial real estate market may persist is uncertain, but the trend presents longer-term financial wins for opportunistic CEO's. Historically, the local commercial real estate market has escalated despite a few dips, downturns and plateaus along the way. The current slowdown in residential real estate is impacting commercial real estate, and that offers CEO's who plan to continue operations in South Florida the opportunity to purchase or lease property at reduced rates.

“We are currently in unchartered waters and no one is clear on where the commercial real estate market is headed in the near term, but if history is any indication, the long-term market will most likely tell a very different story,” says Jerry Lehman, CEO, president and principal broker for Prudential CRES Commercial Real Estate SFL. “Now is a good time for CEO's to look at space requirements and negotiate deals because it’s quickly becoming a tenants’ market.”

Smart Business spoke with Lehman about what’s driving the current trends in the commercial real estate market and where the opportunities lie for CEO's.

What are the drivers that are affecting the current commercial real estate market?

There’s a great deal of turmoil among commercial mortgage-backed securities lenders. Spreads have gone up between the loan index and the desired note rates and the general consensus in the industry is that higher interest rates are having an impact and we’re seeing it reflected through lower sales prices. The commercial real estate market in South Florida has been sizzling hot. The current cooling off period is bringing back more of a balance between supply and demand, and that will help to eliminate overpricing and start raising capitalization rates.

What sector of commercial real estate has been hardest hit?

During the prior boom period, vacant land was allocated toward residential uses for homes and condos. In turn, new housing creates demand for commercial property that is zoned for shopping centers. The residential construction frenzy meant that less land was allocated for office buildings and warehouses. Now, everything has changed. The condo market is deader than dead and the overall slowdown in residential building is freeing up land for other uses. Also, commercial vacancy factors have risen sharply. The overall slowdown in the economy is having an impact on the market for office and warehouse space, which is, in turn, reducing leasing and purchasing costs. If CEO's are thinking about building offices for the future, now’s the time to consider such a move because owners are becoming more realistic about pricing office space for sale or lease and construction prices are dropping .

Are commercial deals still being done?

Yes, commercial deals are still being consummated but much more selectively. Part of the reason for this is that although long-term rates have been falling, spreads have increased. Last year, spreads were as low as 100 basis points, now the spreads are 100 to 200 basis points higher. Higher interest rates mean lower sales prices, and that’s good news for opportunistic CEO's.

With less demand for residential construction, where is the demand shifting?

During the last flurry of residential construction, developers mainly ignored office and warehouse construction and, when the downturn hit, the developers shifted their attention to office and warehouse construction. The new target for this downturn is apartment development. With tougher credit guidelines and increased foreclosures, the demand for residential rental units is up sharply and developers are responding.

What do you see for the near future?

Fundamentally, lenders want to lend and the market will correct itself once again and the housing demand will return. The population continues to grow as the migration to South Florida continues. The absence of hurricanes has lowered insurance premiums and real estate tax relief will encourage more people to relocate to the area. Creation of high-paying jobs, like those in the high-tech field, will place more of the residential real estate within the financial reach of the burgeoning population. I’ve been through many of these cycles, and I know that it can take two years for the correction to work through the market. But, the bottom line is that it always has. I think that the stronger credit required by lenders for portfolio loans has created a situation that makes the collapse of the commercial real estate market highly unlikely. As the economy improves and the demand for offices and warehouses increases, rental prices will escalate. It’s hard to say where the cycle will go next, but one thing is clear — there will always be a future in real estate because the development of America continues.

Being mindful of the details in commercial leases can be profitable.

Ronald A. Schagrin, SIOR
Senior Director
Prudential CRES Commercial Real Estate SFL

Most CEO's review commercial lease agreements with an eye on the legal language and the rental rate, but taking a deeper dive into the agreement’s terms and conditions can have its financial rewards.

“There are issues in commercial leases that CEO's and CFO's may not be aware of, and consequently, they get overlooked during the commercial lease negotiation process,” says Ronald A. Schagrin, SIOR, senior director of Prudential CRES Commercial Real Estate South Florida. “Knowing how to dissect the terms and asking for the appropriate detail behind many of the charges included in commercial lease agreements can save you money. In addition, it’s important to anticipate a number of potential business scenarios that might come up in the future and secure terms that will be favorable to your bottom line under a variety of business conditions.”

Smart Business spoke with Schagrin about the ways that CEO's can save money when negotiating commercial leases.

What are some of the costs that might be hidden in the landlord’s operating expenses?

It’s common for tenants to be charged a pro-rata share of the landlord’s operating expenses, but what constitutes those expenses? Tenants should ask for a detailed copy of the landlord’s operating expenses, review those costs and ask that charges unrelated to building operations be removed. For example, the landlord’s operating expense statement might include legal costs that have been incurred during dispute resolutions with other tenants. You shouldn't’t have to pay a pro-rata share of those types of legal charges. Also, there should be a statute of limitations on when you can be assessed operating expense pass-through charges. It’s reasonable for the landlord to take six months to review his or her charges, reconcile his or her operating expenses and issue his or her assessments. To eliminate surprises, don’t leave the review period open-ended.

What terms and conditions might come into play if my business expands or contracts?

Be mindful of your ability to assign your leasing rights or to sublease your space. If your business either expands or contracts, you may need to adjust your space requirement or your location. Your landlord should not be able to unreasonably withhold your ability to sublease. Another provision that may come into play under changing business conditions is your ability to terminate your lease. Let’s say, for example, that you are five years into a 10-year lease term, and your business is growing, necessitating a move. You want to have the right to terminate your lease without paying a penalty. In that case, the only charges you should pay would be the unamortized costs of the leasehold improvements and commissions.

Which lease terms affect day-to-day business operating costs?

Two things in commercial lease agreements that can impact a company’s ongoing cost of operation are the cure-and-deduct clause and the square footage used in determining your rent. Always verify the square footage of the space you are leasing. Associations like the Building Owners and Managers Association (BOMA) or architects can validate your rental square footage. Also, in the event that your landlord doesn’t repair a problem in your space within a reasonable period of time, like fixing a leaky air conditioner, you want the ability to repair the problem yourself and deduct the charges. Paying for square footage you don’t have over the course of a long-term lease or putting up with business interruption from untimely maintenance can cost you money. Given today’s business climate, you want to make sure that you have a nondisturbance clause in your lease. If your landlord can’t meet his financial obligations and the bank forecloses, you don’t want to be forced to move incurring unplanned costs.

What other cost-savings recommendations do you have for CEO's?

1) Consult with a real estate attorney when negotiating leases.
Every state has nuances to its lease agreements, and CFO's may not be trained to spot the pitfalls and the opportunities to save money. You will definitely achieve return on investment from having a lawyer review your lease agreement. 2) Work with an experienced real estate agent. The landlord pays the cost of tenant representation, and tenants can benefit because the real estate professional will know the current market conditions and he or she will negotiate on your behalf. 3) Keep a signed copy of your lease agreement on hand and diary the critical time lines and key dates. Renewal dates and options contained within leases can pass by unnoticed, unless you keep track of them.

Tie your relocation decisions back to your business plan.

Marisela Cotilla
Managing director
National Services Group
Prudential CRES Commercial Real Estate SFL

Before you pick up a map and select potential new locations or expansion opportunities for your business, you should review your business plan and compose a list of questions.

“The break-even point associated with a move can get away from you if you don’t ask the right questions before deciding on a location,” says Marisela Cotilla, managing director for the National Services Group at Prudential CRES Commercial Real Estate South Florida. “There are many things to consider, and if you don’t have the information you need, you may end up making a costly decision that could have many negative ramifications regarding your business needs and your financial expectations.”

Smart Business spoke with Cotilla about what executives should know before making a relocation decision.

What’s the first thing CEOs should consider?

You need to look at your current customer concentration and decide how your relocation decision will affect them. If you’re looking to expand, will your relocation choice help you capture additional market share? In some cases, location doesn’t affect a business’s ability to garner and nurture clients, but in some industries, it’s critical. If you need close proximity to clients to deliver services or if they need to come to your office to conduct business, that’s another consideration, especially if image and profile are important. A review of your target market and client acquisition plan will help you formulate critical questions to ask prior to making a decision.

What work force data should CEOs review?

Contrary to popular belief, I don’t think that real estate is all about location, location, location. I think it’s all about timing. If you are in the wrong location at the wrong time, you will be unable to attract a quality work force or customer base, so you’ll have execution problems. Demographics aren’t stagnant in any area, so it’s critical to review the current population, density, household income and daytime employment of each location under consideration and ask the following questions:

• How will this move affect my existing work force? Is it too far; will they leave? Will I need to offer relocation stipends?

• Will I be able to attract the workers I need in the proposed location? Do the workers with the required skills live in proximity to the new office? Is there available affordable housing? Expensive housing and long commutes might necessitate higher wages.

• What’s the competition like for workers, and how does my current compensation plan measure up?

• How will these human capital decisions affect my cost of doing business?

Businesses can’t operate without people, so knowing how your new location will impact your work force is vital before making a selection.

How will relocation affect my vendors?

Think about your supply chain and what goods and services you need to receive and deliver to conduct business successfully. If you receive goods via large trucks, you’ll need a loading dock that can accommodate those vehicles and the timing of your deliveries may be impacted, which could adjust your entire manufacturing process. Also, your new location may impact your vendors’ costs and they’ll pass that on to you, so it’s best to confer with them before signing on the dotted line.

What should I know about the property?

You really want to know if the property you’re considering is conducive to your business needs. For example, if you have a large call center, a downtown location that necessitates huge monthly parking costs for employees doesn’t make sense. Additionally, you need to investigate how the phone service in the area may impact your call center’s costs and efficiencies. If you operate a manufacturing concern, can the new building accommodate your equipment? Does it meet your load capacity requirements, and can you move your equipment into the building through the existing doors and elevators? If you deliver your goods to customers on trucks, traveling just a few more miles each day might have a huge impact in your costs and create excess wear and tear on your vehicles. You’ll want to consider toll roads, proximity to rail lines and highways as part of your decision because fuel and transportation costs are major factors. Insurance is another consideration because risks and rates vary by location. Review the long-term plan for the areas under consideration and any regulations that might impact your business. A trip to city hall with a list of questions might be wise because zoning and future development plans for the area are important considerations. Lastly, be sure to consult with real estate professionals who know the area. They can help you formulate questions and they may already have the answers and the necessary data to help you make a financially prudent selection.

Condos offer greater control to small and midsize business owners.

Ted Ciaccia
Senior Director
Prudential CRES Commercial Real Estate SFL

In the recent past, a search for suitable properties in South Florida was often fruitless, as land designated for small-scale buildings was snatched up for larger projects and soaring construction costs placed ownership out of the financial reach for most small to midsize business owners. Now, there’s an alternative. The advent of the commercial condo has brought the benefits of property ownership to CEOs of any size business.

“Business owners don’t get a return from paying rent,” says Ted Ciaccia, senior director for Prudential CRES Commercial Real Estate South Florida. “In today’s world, rent for a commercial space is often only a few dollars less per month than the mortgage payment on a commercial condo and leasing offers fewer benefits.”

Smart Business spoke with Ciaccia about the business and financial advantages of commercial condo ownership.

What’s the business case for buying versus leasing?

In South Florida, the average industrial/flex commercial rental rate is $12 per square foot. Add to that about $4.50 per square foot for the operating expense pass-through costs and sales tax of 6.5 percent and the total effective rate per square foot for leased space is roughly $17.57. Your cost for a condo would be around $15.04 per square foot using these assumptions: 20 percent down, purchase price of $150 per square foot and monthly loan payments of around $10.64 per square foot, then add to that your share of any operating costs and property taxes. You can also deduct your real estate taxes because, with a condo, property taxes are billed directly to the owners; they aren’t included as part of the operating expense pass-through charges. In the buy versus lease financial analysis, after four to five years of ownership, real estate will no longer be an outgo, rather you will be making about $2 to $4 a square foot, given an average market appreciation during that time of $2 to $4.

Won’t condo ownership hamper my business expansion?

I have one client who purchased three units, and now he’s leasing out two of the spaces until he needs them. He not only receives the financial benefits from his purchase in real time, but he’ll save $50,000 to $100,000 by avoiding moving costs when he’s ready to expand his business. The other consideration is that lease rates continue to escalate whereas the condominium payment is fixed. Having fixed real estate costs frees up capital for investment and facilitates long-term planning, not to mention the fact that you’re building equity, which can be used for future business expansion.

Will ownership facilitate unique real estate requirements?

The inability to supply ample parking ranks second highest on the list of commercial real estate failures. Business offices are typically allocated only three to four parking spaces per 1,000 square feet of space in commercial leases, yet doctors, for example, require at least five to six spaces for each 1,000 square feet. In commercial condominium projects, there’s more flexibility, especially around things like parking allocation, and often, the buildings are designed around industry-specific needs. Here in South Florida, for example, you generally have to lease a building with at least 10,000 square feet to get a dock-high loading area, but with a condo, the buildings are often customized to meet the needs of service-oriented manufacturers, so owners can have access to those special amenities without the huge lease. Further, commercial condo ownership allows business owners to renovate their space, designing their interior build-out for customized needs. Because you won’t face the prospect of moving every few years, necessitating that you leave your tenant improvements behind, you’ll feel better about investing in your space, which is great news for physician owners, who average a 25 to 30 percent higher build-out cost than traditional office dwellers.

How does ownership afford greater control?

First, there’s no absentee ownership with condos and owners have pride of ownership when compared to renters, which is reflected in the building and grounds maintenance. Also, while landlords have an obligation to hold operating costs down, there’s really no motivation under a leasing structure to do so. As a result, pass-through costs often escalate while the quality and responsiveness of the building management team can be less than adequate. As an owner, you’ll have a voice in how things get done, how the building looks and, if the owners choose to outsource the property management, you’ll be able to weigh in on that organization’s selection. Lastly, you no longer face many of the business restrictions imposed by leasing.

Ask in-depth questions to uncover unforeseen charges.

Mara Porras, CPM, CCIM, RPA
President
Prudential CRES Property Management SFL


Many prospective tenants automatically assume that common area maintenance costs are the same from one building to the next, and many never even inquire about what they include. It is also important to know who the landlord is that they’ll be dealing with, and who the property management firm is, before signing a lease.

“You’d be surprised,” says Mara Porras, president of Prudential CRES Property Management. “Sometimes, tenants are responsible for certain expenses within their premises (i.e. HVAC repairs, janitorial expenses or plumbing repairs), which they may not be aware of unless they read their lease thoroughly. These issues won’t come up during lease negotiations unless prospective tenants bring them up, so the best thing to do is ask a lot of questions and know all of your financial liabilities before signing on the dotted line. What may be referred to as customary is often not practical nor financially profitable.”

Smart Business spoke with Porras about what questions CEOs should ask before signing a lease agreement.


Why does the property management company matter?

It is important to know who is your landlord and/or property management company. The property management team is the ‘face’ for the ownership; they are the ones who oversee the maintenance of the property. The responsiveness of the management team reflects the owner’s commitment. It is important to know the involvement that the ownership has in the operation of the building, and it is important to know the management team and its response to the day-to-day maintenance issues that may arise. Many times, tenants do not give much consideration as to whom they will be dealing with once the lease is signed. It is only once something goes wrong (i.e. maintenance issues, increase in operating expenses or management issues) that they then want to know who the parties are.

What should CEOs ask about building operations?

You want to ask about and become familiar with the building rules and regulations because they may affect the way your company does business as well as your bottom line. Some questions to ask are:

• Is the building ADA compliant and, if not, how does that affect your work force, and whose financial liability is it?
• Are you allowed to leave your company vehicles in the building parking lot overnight?
• Do any of your employees smoke, and if so, where are the designated smoking areas?
• If you want janitorial service during the day instead of during the evening, will they accommodate your request and at what cost?
• Are you separately metered?

Today, many employers are very concerned about providing adequate security for their employees, especially if they work evenings and weekends. Inquire about building security and if the cost of security is included or if it’s invoiced separately to each tenant. Ask what time the building doors are locked because access limitations may affect your customers and your business.

What hours does the building HVAC system operate, and can you operate the system after hours; what is the charge for this? If your business receives deliveries (i.e. large and/or heavy equipment or files), does the building have the ability to accommodate these deliveries? Does the building have the floor load to handle this? Are there designated hours to receive deliveries?

And of course, here in Florida, you’ll want to know who determines when the building will be closed and when it will open following a major weather event like a hurricane.


What should CEOs know about equipment maintenance?

Do you require a backup generator? Who is responsible, and how many companies are connected? You will also want to know who is responsible for maintaining the general building equipment (i.e. HVAC equipment, plumbing repair, electrical repairs, elevators). Does the space require special lighting and, if so, who is responsible for the replacement and repairs?If you generate large quantities of rubbish (i.e. boxes, pallets, etc.), ask if there’ll be an additional charge for disposal.

What questions might expose hidden costs?

Ask about insurance and when it is scheduled to renew; get a history of what the premiums have been for the last two years. Insurance in South Florida can increase tremendously depending on whether or not we have an active hurricane season. This is an expense that all owners must be aware of because it can affect the bottom line. If the building was sold within the past year, has the building value been reassessed, and do the real estate taxes reflect the new assessment? Are there any major repairs and replacements planned for the building? Are there any code violations pending that could be considered a pass-through to the tenants? It is critical to ask a lot of questions. You are the only one that knows your business and your requirements.

What to consider before constructing a new facility or renovating

Michael Scarpino, CCIM
Senior director
Prudential CRES Commercial Real Estate in South Florida


The idea of moving your business into a brand-new custom building can be tempting. The benefits of a floor plan tailor-made for your business might be worth any additional costs. On the other hand, renovating an existing building might be faster and less expensive, but compromises might be necessary. One thing is certain, both choices have their pluses and minuses, so in order to make the best decision, CEOs should investigate the costs, feasibility and time required for each option because mistakes can be costly.

“When you opt for new construction, you need to be certain you’ll be able to get the building permits and land entitlements you’ll need or else the project just won’t happen,” says Michael Scarpino, CCIM and senior director with Prudential CRES Commercial Real Estate in South Florida.

Smart Business spoke with Scarpino about what CEOs should know before deciding between building and renovating.

How do entitlements and zoning impact the decision to build or renovate?

There might be fees and zoning issues associated with brand-new construction on vacant land that you won’t face if you opt to purchase and renovate an existing building, simply because the land use is established and the supporting infrastructure is paid for. With new construction, you might be assessed impact fees for the building of roads or sewers, and it might take some time to investigate whether the current zoning will support the proposed construction plan or if you’ll be able to get the necessary entitlements for things like parking. It’s sometimes possible to purchase vacant land that is already platted, meaning the entitlements and land use have been decided, which will save time and money. Sometimes under the right circumstances, new construction is not more expensive than renovation or it’s worth the extra investment to get exactly what you want.

How does location impact the decision?

The location of the property has a huge financial impact, especially long term. If your business needs proximity to rail lines or major highways, that requirement might be the most important decision criteria, and if the land is vacant, you’ll need to know if and when the long-term master area plan provides access to major transportation lines. Also, neighbors may pressure local officials to turn down your plan, if they perceive it will have a negative impact on traffic, community aesthetics or property values. Last, accessibility to a work force with the required skills is a major location consideration because having to pay long-term premiums to commuting workers can eat away at savings gained through an advantageous construction or renovation deal. Both the state of Florida and some local governments offer incentives and tax advantages to businesses that locate within enterprise zones, but only a thorough analysis can determine if this might be the right move for your business.

What’s the time required for each option?

Generally, the escrow and due diligence process required to purchase an existing building takes about 90 days, and then renovation can take anywhere from three months to two years, depending upon the extent of the construction. When building from the ground up, expect a six-month escrow and then six to nine months for construction. If you need to move quickly or during your business’s off-season, do your homework because it’s very costly to move twice or take short-term lease extensions. It’s also important to factor in the costs of production downtime or the options of moving in stages versus all at once. Run a profit and loss statement for every possible scenario, looking at all the impacts and costs, in order to make a sound, unemotional business decision.

How do industry-specific construction requirements factor in?

Build new or renovate decisions are often greatly influenced by the extent of renovations required to retrofit an existing structure. For example, if your company stores dry goods and that necessitates extensive architectural and engineering changes to an existing building in the form of new ceiling heights, ventilation, fire sprinklers and loading docks, you might be better off with new construction. If the previous owner was in a similar industry and the building flows properly, renovation might be more cost-effective.

What should CEOs do to evaluate their options?

The best thing CEOs can do is surround themselves with experienced professionals who will provide honest recommendations and expert advice, not just tell them what they want to hear. Consider a team approach that includes a lawyer, accountant, banker, a real estate professional, the architect and the engineer to help you evaluate your options and navigate the process. Check their references because inexperience can lead to mistakes.

Published in the

A6. Wednesday, June 11,2008 . Daily Busness Review

Dealmakers by Review Staff


Broker helps water treatment company lease green space





Dealmaker: Broker Ronald Schagrin

The Deal: In a 10-year deal valued at almost $6 million, Parkson Corp. leased 35,000 square feet of office space May 30 for its new corporate headquarters at the Crown Center business park in Fort Lauderdale's Cypress Creek area.

Details: After more than 20 years in a 25,000-square foot space elsewhere on Cypress Creek Road, Parkson opted to lease almost half of a 76,000-square foot building in the Crown Center complex at 1401 W. Cypress Creek Road. The Building is owned by Fort Lauderdale Crown Center Inc. The company's lease had expired at the previous location.

Parkson, a wholly owned subsidiary of Axel Johnson Inc., provides treatment technology to manage sludge, potable water, wastewater and water re-use.

The company wanted to move to a "green" building that met the U.S. Green Building Council's Leadership in Energy and Environmental Design guidelines. The Crown Center owner is working to make the campus more environmentally friendly, Schagrin said.

The charges include an energy-efficient roof and utility room prepared for the installation of a generator.


Background: Schagrin, senior director of Prudential CRES Commercial Real Estate in Fort Lauderdale.

No matter how dark the cloud may seem, there’s always a silver lining. For those with good credit and good investment sense, the silver lining just might be the abundant opportunities in the commercial real estate market. Banks, reeling from the credit crunch, have money to lend and need to rework their books of business. With underwriters on the hunt, creditworthy borrowers should be searching for good properties if they want to take advantage of the current opportunities in the commercial real estate market.

“Banks need to lend, but they want quality deals,” says Jerry Lehman, CCIM, SIOR, CEO, president and principal broker of Prudential CRES Commercial Real Estate SFL. “Interest rates are close to all-time lows, and the liquidity crisis on Wall Street has had a major impact on the commercial real estate market. This is an opportune time to look at investment properties or leasing space.”

Smart Business spoke with Lehman about the impact of the liquidity crisis on the commercial real estate market and how savvy investors can capitalize on the current opportunities.

How has the Wall Street liquidity crisis created opportunities in commercial real estate?

Many Wall Street firms are reeling from losses in the subprime residential mortgage market. These firms began pulling out of commercial mortgage commitments in order to protect their cash and liquidity. Also, many individuals with large amounts invested in money market auction-rate bonds were shocked to find that their funds couldn’t be withdrawn because the market for these bonds disappeared almost overnight, freezing the money market deposits. All of these events have had a profound impact on the commercial real estate market. There are more sellers than buyers, prices have fallen and lending rates are favorable. For investors or executives that have a specific real estate need, investment goals and good credit, the opportunity to make a deal has never been better. While there’s less competition for good buildings, there are also fewer lenders funding deals because the institutional lenders are virtually gone.

What are the best deals right now?

Multifamily residential properties are currently good investments. With many families losing their homes, vacancies are on the decline, so apartment buildings are attractive right now. Also, small and midsize industrial buildings, anything under 50,000 square feet, are a good investment because there’s always a shortage of those on the leasing market, so you’ll generally have no problem finding tenants. Office buildings currently have higher vacancy rates than normal because many real-estate-related businesses have closed. But if you can hold onto the property for a while and ride out the current economy, it will be a good investment as the occupancy rates improve. The best value of all is vacant land. Owners are desperate to sell, but vacant land is definitely a longer-term hold. So if you invest in vacant land, plan to keep it for a while.

What are the current lending qualifications?

You’ll need 20 to 25 percent down and good credit. It certainly helps if you come into the bank and open a new account because new depositor relationships will garner a more favorable rate. You’ll also need strong company or personal financial statements, and the cash flow of the property you’re considering needs to be favorable. Banks want quality properties and quality deals right now. Quality properties are defined as those with a good location and good demographics for the specific use. For example, if the purchase involves an industrial or office building, they’ll consider the location, cash flow and the strength of the tenants in assessing the deal, and they’ll also consider the physical condition of the property.

What professional support and relationships will investors need?

Even if you’re conducting a small transaction, it’s advised that you are assisted by a lawyer and accountant, but you’ll surely need that type of professional support to act as an advisory team for larger transactions. If you have a current banking relationship, it’s helpful, but if not, a qualified broker with solid community relationships should be able to refer you to a lender. Also, make sure your broker understands the marketplace and your needs so they match you with the right property for your budget and your investment goals.

How pre-sold commercial conversions can benefit buyers and sellers

Jonathan H. Lehman
Legal Counsel
Prudential CRES Commercial Real Estate SFL


Almost every executive is or has been impacted by today’s economy and real estate market. But, many developers are finding relief by converting existing commercial properties to condominiums.

When a property changes from sole ownership to individual unit ownership, developers can reduce risk by securing commitments from unit buyers before even acquiring the title to the property, which appeals to purchase money lenders, and there may be little cash required to finalize the transaction.

“By converting to condos, developers turn otherwise un-noteworthy rental assets into property that becomes attainable for would-be buyers,” says Jonathan H. Lehman, legal counsel for Prudential CRES Commercial Real Estate SFL. “The event of converting is especially appealing when a buyer is involved in the condo creation.”


How do conversions benefit developers?

When developers secure condo unit buyers and acquire a property simultaneously with the condo conversion and sale of units, there’s minimized risk of unoccupied real estate sitting on the market for a long time. Developers can assure lenders and secure financing accordingly. A properly executed simultaneous conversion produces equity from the sale side for immediate application toward the acquisition side, as opposed to new construction, where developers face a major capitalization requirement. These conversions require only the difference of cash-to-close minus condo sale proceeds, if such a differential exists. Developers stand to walk away with a substantial profit and they could be in and out of the transaction relatively quickly. With residential condo construction, buyers are asked to buy on speculation and developers could be tied to a project for years. Also, non-residential conversions face little or no governmental review.

What are the benefits for unit owners?

Individual unit owners who have leverage by way of tactful contract negotiations can insist on being involved in the initial set-up of the association and the drafting of the governing documents, which isn’t on the table when buying in an existing condominium. Owners get more control and input opportunities, from voting power and assessments to rules, regulations and signage. When units are pre-sold prior to conversion, owners reduce the risks associated with purchasing a unit in an undersold project subject to developer solvency. Those currently leasing space have the opportunity to switch rental expenses to real estate investments, which could pay off well once the market rebounds.

What are the steps for converting?

A developer involved in a pre-sold commercial condominium conversion must:

• Assemble professionals. A conversion is law intensive and there are many considerations that must be reviewed with your lawyer. Your broker can assist with marketability and prospective profitability based on local comparables. Also, surveyors, engineers and other specialists must be retained to complete the project. As with any real estate project, make sure your professionals will commit to your budget and time frame.
  
  
• Identify the right property. Find an existing building that has uniformity of space, so it will divide easily and equitably, and be conducive to multi-unit access. Targeting a specific clientele is an option, but it must be permissible in the jurisdiction and practical with respect to market absorption. Having ‘Class A’ construction is helpful because it appeals to condo buyers on an emotional ‘gotta have it’ level. After all, the necessity for a developer to contribute capital and time toward improvements diminishes the attractiveness of this type of project and threatens to interfere with a fragile time schedule.
  
  
• Run a financial analysis. Run a market analysis, set prices for the units and be certain the sum of the parts will be greater than the total cost. Aim for enough capital through pre-sale activities to close on the acquisition. Be wary of small concessions to buyers because the aggregate cost could equal a significant blow to the bottom line.
  
  
• Secure buyers and draft documents. Focus on selling units to effectuate the simultaneous acquisition and conversion. The quality of the buyer and likelihood of closing on time are important considerations. Negotiate and draft the governing documents and make sure the buyers will be properly represented in the association. In some cases, the developer will have to act as an umpire to balance the long-term sustainability of the condominium where separate unit owners are inclined to push for control.

Proceed to the close. At closing, your lawyer can facilitate the acquisition closing, condo creation and unit re-sale closing.

Is there a downside to conversions?

If a key party defaults, which is largely out of your control, there’s always the potential to lose money on the project and face repercussions. The reality exists that the market may not have yet bottomed out, and unit owners could experience a loss in the value of their units after purchase. The entire scheme is not cheap: the developer will, among other things, get hit with double closing costs, whereas the buyer will likely need cash to close. Both developers and unit purchasers should consult their accountants to assess further financial disadvantages.

Building a national company is the dream of many entrepreneurs, but launching a new franchise or opening a distributed group of sales offices means securing real estate in new areas, and that requires knowledge of the local market.

In the past, many executives created infrastructure and hired staff to procure and manage commercial real estate as part of an expansion plan, yet those staff members often turned to local real estate brokers for marketplace expertise. Now, smart CEOs are finding they can secure the knowledge without the overhead by outsourcing their company’s real estate function.

“Operating a national real estate portfolio can be overwhelming,” says Jerry Lehman, CCIM, SIOR, president and broker for Prudential CRES Commercial Real Estate SFL and executive vice president for Prudential CRES National Services Group. “It’s time-consuming and it’s expensive. No matter the size of the company, if your reach moves beyond your local neighborhood, it’s possible to outsource everything from site selection to lease management without increasing costs.”

Smart Business spoke with Lehman about the advantages of achieving growth without increasing overhead by outsourcing your company’s real estate department.

Which commercial real estate functions can be outsourced?

The entire scope of the real estate department can be outsourced, including market surveys, initial site selection, the due diligence process, property inspections and ongoing lease management. The services can also include monitoring lease expiration dates, negotiating lease renewals and conducting day-to-day communication with landlords about needs like increasing the parking spaces at a remote sales office. Many national commercial real estate companies offer turnkey outsourcing programs.

What are the advantages of outsourcing?

Real estate is a local business. While you can review local area demographic data such as population, income and age when considering a new location, selecting the perfect spot requires a composite analysis of data and human intelligence. Unless you’re familiar with the local market, you won’t know about recent changes in property use, new roads, proposed exit ramps or if employers are leaving the area and why. The most critical player is the local agent who must understand your business needs and match them to the local market. In most cases, internal real estate staff members will turn to local agents for that knowledge and expertise, so outsourcing further leverages your buying power, reduces overhead and gives you a committed relationship with a national network of agents located in major urban and secondary markets. While you’ll work with a number of agents, you’ll have one contract to manage and you’ll work through the company’s account managers and regional directors. They’ll become experts in your business, your real estate needs and your long-term business objectives and then transfer that knowledge to the local agents, when you need to secure a new location.

What are the costs and the potential savings?

There’s no cost to your company because the landlord or seller pays agents’ commissions. The result is a huge savings opportunity; at most, you might need a small internal team of one or two people to manage the outsourcing relationship educate the account managers about your business requirements and manage your company’s portfolio of leases. I’m familiar with one large retailer that manages a portfolio of 1,600 store locations with an internal staff of only three people. Without outsourcing, it would take a minimum of 50 people to manage a global real estate portfolio of that size.

Will outsourcing change the fiduciary relationship between brokers and clients?

If you choose to outsource your company’s real estate department, the broker’s fiduciary relationship will remain with you, the buyer. Typically in a real estate transaction, the landlord or the seller pays the broker’s fees, so the industry standard is that others pay the costs associated with the broker. The party who pays and the agency relationship are not necessarily related in commercial real estate transactions.

What selection criteria should CEOs consider when selecting an outsourcing partner?

Select a company with a strong geographic reach and extensive commercial real estate experience, because you want to select a partner that has some muscle in the field and the resources to manage an outsourced engagement. Review the company’s locations to make sure it has an office in the cities and countries where you plan to expand. Understand their account management structure, because once the contract is in place, those people are vital to the success of the relationship. You’ll want to know if you’ll have a single point of contact and how they communicate information about your needs to brokers located across the country or the world. Consider checking references to validate a potential vendor’s experience and commitment. Then sit back and enjoy the benefits of growth without the expense.