Case by case considerations when deciding whether to buy or lease.

While every case is different, there are certain underlying factors that drive the best decision in most buy-lease scenarios. These factors are the availability of capital, the alternative use of capital, and the anticipated growth of the firm.

Consider capital availability

One of the most important factors in evaluating leasing and buying is the availability of capital. The down payment and other significant costs in closing are the reason that relatively young companies rarely are able to buy real estate. All firms need to evaluate their capital requirements when deciding to buy or lease, not only now but in the foreseeable future, to ascertain that the real estate does not take a disproportionate bite out of their cash reserves.

Consider capital requirements

Closely related is a firm’s evaluation of their alternative use of capital. This completely depends on the business of the firm and the capital requirements of their product or service. As an example, if a manufacturing firm can generate a 30% return on every dollar invested in the manufacturing of widgets, it would hardly make sense to invest the same dollar in bricks and mortar.  Because of this, and that fact that a lease is a much cleaner exit strategy, there are many Fortune 500 firms who have an established policy of leasing space only for just this reason.

Consider anticipated growth

Finally, the anticipated growth of the firm is very important in evaluating a buy-lease scenario because the majority of the expenses in a purchase are upfront. If an insufficient time is available to amortize these expenses, e.g., a relocation of the company three years later, the unamortized expense will make the purchase scenario much more expensive. We have conducted cash flow analyses for our clients who are trying to decide to lease or buy, over many years, and typically find that the break even point in a buy-lease  scenario is somewhere within a five to seven year span. So our general advice is to avoid buying a building if a move within the next five years is contemplated.

Cash flow analysis

This also means that buying real estate is typically more appropriate for established, stable firms. Fast growing firms, especially those who have trouble forecasting even three years in advance, should concentrate on leasing. Whether you lease or buy, the cash flow analysis is appropriate in every situation, as it can be used to compare multiple lease or multiple buy scenarios, as well as a comparison of the two.

To properly compare these factors and their results, a cash flow analysis should be prepared. This cash flow analysis will show the inflows and the outflows during the desired holding period. Each of these cash flows is then discounted back to its present value ($1.00 today is worth more than $1.00 spent ten years from now.) In this way, any number of lease and buy scenarios can be compared to one another in a very objective mariner. As an example, a company may compare a ten-year lease with a buy. The lease in a cash flow analysis will usually reflect a steady series of outflows that increase with each passing year. A buy on the other hand, will show a down payment in the first year, fixed series of outflows each year, representing a constant mortgage payment, and a sale of the property in the tenth year. In each case, certain assumptions must be made, such as a discount rate and market appreciation.

In summary, when deciding whether to buy or lease there is no one solution that applies to every firm in answering the buy-lease question. But with the proper evaluation of these factors in a cash-flow analysis, a clear answer will usually emerge.

David G. Hunt

How do you choose a commercial real estate broker?   

This is how we choose a real estate agent when an assignment takes us out of our home base of Long Island.  In that case, we often need the expertise of a local agent to assist us with properties, zoning, economic development opportunities and the like.

First, we will only work with one broker exclusively. The primary reason is that we want that agent to legally represent our client’s interests. In New York State, a real estate agent has a fiduciary responsibility to protect the seller or landlord’s interests, unless there is a written document to the contrary. So we make sure that we have a contract. And because we are working with only one broker, we take care to select that broker carefully.

We usually start with one of the professional organizations that we belong to, depending on the nature of the project. The Society of Industrial and Office Realtors (SIOR) is a division of the National Association of Realtors. A broker who has an SIOR designation is in the top 4% of commercial agents nationwide, and must not only pass a rigorous educational and testing program, but must also demonstrate transaction volume that is significant for his market. You can locate an SIOR broker in the marketplace of your choice at www.sior.com. A similar designation, with the same rigorous requirements, is the Certified Commercial Investment Member (CCIM). A CCIM is more focused on investment real estate, and can be found in your area at www.ccim.com.

We find that personal recommendations are very helpful, but not so easy to obtain out of the area. But if you are considering real estate locally, I would reach out to your network of business owners, perhaps a trade group, and ask for recommendations. Personal experience with a broker tends to cut through the fluff and promises of a great presentation but poor follow through.

Next we want to make sure that the broker and the office that we have selected has the inventory and tools to help us. We would like to see sample reports, spreadsheets, and the work that they have done for other clients. Have they worked on similar projects? Is this their area of expertise? We do not want our project to be a learning curve for the broker! I also want to make sure that my day-to-day contact is with a senior level broker. All too often a senior level broker makes the initial presentation, but 90% of the project is handled by junior salesmen with limited experience.

And finally, we make sure that we’re working with someone we like! Life is too short to be working with someone who is difficult or annoying. There are usually a number of really qualified agents in any marketplace, and there is no reason you cannot locate someone that fits your personality.

 So, there you have it! This is a process that has worked well for us, and I am sure will lead you to a more than satisfactory real estate experience with the commercial real estate broker that you choose.

David G. Hunt

What is the best way to unlock the equity in your building in today’s real estate market, and “cash in your chips?”

If you have owned and occupied your commercial or industrial building for many years, it may be close to being fully depreciated.  Your building may be worth much more than you paid for it, but has been depreciated down to close to the land value of many years ago!  How do you “cash in your chips” and tap the true value of your real estate?  

There are three major methods, none of which is the “right” decision.  There are advantages and disadvantages of all three.

1. The first, and probably most obvious choice, is to refinance the building.  The major advantage of refinancing is that there is no tax consequence, since loan proceeds are not considered income.  The major disadvantage is that only a portion of the property’s value can be tapped.  This is governed by the loan to value ratio of the lending institution that is making the loan.  As an example, with a loan to value ratio of 70% (fairly common) you could only obtain a loan of $3,500,000 based upon a property value of $5,000,000.  Another disadvantage is that if the operating company owns the building, the loan will show up on the balance sheet as debt.
2. Another common way to tap real estate equity is a sale-leaseback.  You sell your building to an investor, who in turn, leases the building back to your operating company.  One advantage to a sale-leaseback is that you are accessing 100% of the property value.  Another advantage is a much stronger balance sheet if the operating company owes the real estate.  The depreciated building will be replaced with a healthy influx of cash.  In addition, unlike traditional bank debt, sale-leasebacks to do not need to be refinanced, with initial terms and options available up to 49 years.  The disadvantage over refinancing is that there will be federal and state taxes to pay on your gain, which is the difference between the sale price, net of expenses, less your adjusted basis in the property (not what you paid for it.)
3. Finally, you may want to consider selling the building and relocating.  One advantage of this method is that you are selling your building to another user, and generally maximizing the sale price.  And of course, you are accessing 100% of property value, as in a sale-leaseback.  The disadvantages are once again the tax consequences, as well as the cost and inconvenience of moving.  But if your business requires more or less space, or more modern quarters, the cost of the move may be recovered quickly.

These choices required a full evaluation of your accounting team, particularly if a separate holding company owns your real estate and not the operating company.  You should explore all three alternatives to see which is most advantageous for you.

David G. Hunt 

What is the optimum term for a commercial lease from the tenant’s point of view?

A good question, but there is no “one-size fits all” answer on this one.  The tenant’s objectives play heavily into a decision on lease term.  Let’s talk about some of the trade-offs involved in the decision.

The advantage of a longer term lease (seven years or more) is that they are very desirable from the landlord’s point of view.  Thus, significant concessions can often be negotiated in exchange for a long-term lease.  These can include items such as an expensive workletter or free rent.  The disadvantage of a long-term lease is that you have mitigated one of the major advantages of leasing, and that is flexibility and an easy exit strategy.

The ideal solution for a tenant usually lies between the two extremes in a compromise of advantages.  The average lease term today for industrial and office real estate is five years.  As a tenant, give yourself some flexibility with options.  We recently negotiated a five-year lease transaction for a tenant that included a five-year option to renew, and an option to cancel the lease on six-months notice.  Now that is flexibility!  Options are a one-way street in the tenant’s favor.  Negotiate as best as you can, but ultimately accept any option that you can get!  Down the road, if conditions are favorable, you will exercise your option.  If not, you will be sitting down with the landlord to negotiate.  You have control over the option, not the landlord.

What are the differences between a net lease, a gross lease, and a full-service lease?

These are all terms that are used to describe the manner in which services and expenses are paid in a landlord-tenant relationship.  While the terms are used freely in commercial real estate transactions, there are actually no agreed-upon exact definitions of each.  You should be concerned with the total cost of occupancy, so it is crucial to sort out what services are included in the rent, and incorporating the cost of those that are not.  The following are the generally accepted definitions of these terms:

A net lease refers to a base rent that is being paid solely for the real estate, and does not include payments for real estate taxes, utilities, insurance, and any other operating expenses.  A good way to remember the basis of a net lease is to equate it with the mortgage payment of an owned property.  If you own a property, your mortgage payment is generally due once a month, just a like net rent, but you are also responsible for tax payments, insurance, all operating costs and even the landscaping!  A net lease is similar.  The rent paid to the landlord is simply compensation for his investment and risk in the real estate, and no more.  The so-called triple net lease (usually encountered with single-occupant buildings) puts the entire burden of these expenses upon the tenant, in addition to the net rent that is paid.

A gross lease, on the other hand, usually incorporates some of the operating expenses (almost always real estate taxes) in the rent that is paid to the landlord.  The gross lease may or may not include building insurance or common area maintenance (CAM).  The tenant must take it upon himself to inquire as to exactly what is included in the gross rent that is being quoted.  On Long Island, for example,CAM and building insurance can easily add an additional $0.60 a square foot to the quoted price if they are not included in the gross rent.

Full service leases are almost exclusively encountered in office buildings.  They have, as the name implies, a rent that supposedly incorporates all of the tenant’s cost of occupancy.  A typical full service rent will include the base rent, real estate taxes, insurance,CAM, heating, air-conditioning, cleaning, and rubbish removal.  A “full service plus electric” adds an additional charge to the tenant rent for tenant electric use (lights and outlets).

The definitions for these terms are hazy, and by no means universal.  It is therefore incumbent for you to compare alternative properties and their prices with a full understanding of the total cost of occupancy.  It is important that you ask the necessary questions and dig as deep as necessary to fully itemize the expenses. This is the only way a true economic understanding of the real estate alternatives or pricing can be made.

David G. Hunt

The "Before"

I am always amazed at the number of landlords or sellers who market their property while it remains in an either unappealing or deplorable condition.  Yes, there are some buyers and tenants who have the vision to see past the poor physical condition of property, but the vast majority cannot.

There are probably two reasons for landlord and seller apathy:  They don’t want to spend the money, and they also are not aware of the impact on their prospect.  Many property owners have seen the “before and after” so many times they can literally walk through the property and envision it in pristine condition.  “I’ll do the repairs when I have the tenant” is the logic.  What they don’t realize is that when a tenant walks through property and sees stained ceiling tiles, he thinks the roof needs to be replaced.  An overgrown landscaping bed always means that a landlord does not take care of his property.

The "After"

“Getting-ready-for-market” work is often a lot more economical than you may suspect, and will usually bring back multiples of the cost in an increased rental or sale price. And here is a convincing argument: before a tenant takes occupancy the landlord or seller will probably have to do this work anyway!  Much better to do it beforehand and reap the marketing benefits!

These two photos illustrate a building clean-up by Hunt Construction Services last year.  Which one would you rather lease?

For the techniques of making property sparkle on a budget, click on my article on the subject:

Property Sparkle on a Budget

By investing the time and money to create a positive impression in the eyes of your prospect, you will help ensure that your property is leased or sold quickly.

David G. Hunt

If you are planning commercial construction or renovation of some kind, there are two types of construction estimates.  You need to be aware of the advantages and disadvantages of both.  A “budget quotation” is a rough estimate of the costs of construction which is prepared without a lot of detailed information on the quality or type of materials.  A “contract bid” is a price for which the contractor is prepared to build, and is usually based on a complete set of drawings and/or outline specifications.

Why would anyone want a budget quotation?  Hunt Construction recently provided a budget quotation to a Huntington businessman who was interested in expanding his building.  An architect had prepared a single page plot plan showing an outline of the proposed addition on the site.  That’s all there was.  But enough for a budget quotation.  In this case, a budget quotation helps our client make a GO/NO-GO decision.  Will he be able to finance the addition?  Will the additional carrying costs and taxes be more than offset by the additional business that can be booked?  Our client did not want to bear the cost of a full set of architectural drawings before having an understanding of the scope of the project.

    A contract bid, on the other hand, should be based upon very tight specifications (down to the last doorknob) and a complete set of plans.  If this is not done, the result will be construction bids that vary widely based upon what each contractor believes you want.  So a complete set of plans is the last place where you want to skimp!

David G. Hunt

I have always taken “leading economic indicators” with a grain of salt.  But there are signs out there that the logjam is finally breaking up.  A barometer that I have used for years is, “How often are our properties being shown by the entire brokerage community?”  Showings are at a three-year high at the moment.

We recently met a manufacturer and distributor of B2B shipping products.  His type of product is used by nearly every manufacturing and warehousing company in the country.  He needs more space, reports that his product is flying off the shelf and is struggling to keep up with the demand.  Hmmm…

Yes, there is something going on out there.  Other news:   “CoStar’s monthly National Composite Index of commercial real estate real estate prices increased 2.2% in October from the same period a year ago, the first year-over-year improvement since the economy too a sharp downward turn in 2008.”  Also, “Existing home sales continue to climb in November according to the National Association of Realtors.”

There are enough of these signs that I am finally believing that this is not a short-term aberration.

David G. Hunt

Winter is knocking at our door!.  Are you wondering what you can do to help keep those heating cost down?  Here are some suggestions:

Make sure your windows and doors are properly sealed.  They may need re-caulking.   They may even need to be replaced.  Check to see if the rubber slides at the bottom of the doors are working properly and are in good shape.  Don’t forget about the garage doors.  Make sure they are sealed properly also.

What about the exterior wall penetrations such as water pipes, waste pipes, oil feeds and gas feeds.  Are these penetrations sealed so water doesn’t get by?  You may need to add expanding foam or seal openings with concrete.

Check to see if your thermostats are properly set so you’re not heating an empty building.