Investors in commercial real estate come in many shapes and sizes.
As you may remember, I define an investor as someone who depends on the rent an occupier pays for their livelihood. Institutional, public or private investors have this requirement in common: a paying tenant.
You may be wondering if investors are buying a vacant building? Of course, but trust me. They include the time and expense required to create a tenancy. If they miscalculate, there is the return on their invested dollars. And this loss can never be recovered.
Recently we were engaged to help a private investor redeploy proceeds from the sale of another commercial property. It defers the gain through the use of a 1031 exchange.
If you are unfamiliar with an exchange, here is a brief description. A seller completes a transaction and the product is placed with a qualified intermediary. The clock starts. A replacement must be identified within 45 days and purchased before 180 days from the close or next year’s tax return filing date. An equal amount of dollars and debt should be spent on a similar income property (or properties). If orchestrated correctly, income taxes on the gain are deferred. It sounds simple. But please consult with your tax, accounting and real estate professionals before proceeding.
Last week we visited a few alternatives and I thought our conversation was worthy of a column.
While his property for sale was in receivership, we spent a few meetings discussing the qualifications for the purchase. The result is a desire to acquire a single or two-tenant industrial building with a triple net lease. Yield should be north of 4.5% and should provide a reasonable remaining lease term. The tenant’s credit is important and the rent paid must be at or below market.
First on our list was a single tenant property that could be divided once the tenant leaves. Currently the building is occupied by the owner who is moving out of state. Because his new business house is not yet complete, he is looking for a short-term lease of one year to 18 months.
After the first viewing of the property, we looked at option number two. The occupant of the building once belonged to the owner of the building. We often see this when a business owner decides it’s time to cash in the tokens, but sees the value in retaining ownership of the real estate.
In this case, now is the time for the property owner to move their money to a more tax-friendly state, hence their motivation to sell. Met was an operation that has a significant sum of money invested in the infrastructure of the building and 4 and a half years remaining on its lease. Located in an emerging area – but not quite mature – we felt that we were a bit of a pioneer.
Here is what our client had to say about the two alternatives.
He really likes the first building we visited, although he understands that an amount of money for the relocation of the building must be taken into account. After all, this will be resolved at the beginning of 2024. Our client was worried that the building owner would have time until his new building was finished and therefore was not very motivated.
Additionally, the owner had unrealistic expectations for the value of the property, particularly given the economic storm clouds we see gathering on the horizon of inflation, rate increases and the threat of inflation. He will deliver, but at far less than the asking price.
On the way to the wild Wild West. We found out that the owner of this building would like to take out a loan. If favorable terms can be negotiated, it could actually be a win. Because the property is located in a developing area, the length of the lease becomes of crucial importance. Insufficient are the 4 and a half years that remain. Therefore, we will ask for a longer term at the closing of the escrow.
Ok, nets cast. It’s time to reap the bounty of investor interest.
Allen C. Buchanan, SIOR, is a principal at Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104.