A short list of ways to lose money when investing in commercial real estate.

This week we are re-running a popular post from years back, but the advice still holds true.

I’m often asked “what are the best market conditions in which to buy investment real estate?”  As the market finally begins to show signs of improvement, MacRo Ltd. is getting that question more often these days.

My simple answer is that any market will work. A savvy investor is capable of finding a good deal in any market. It’s really more about having clear and realistic goals, the appropriate capital resources, a strong management plan, as well as a patient yet diligent approach to achieve the goal — a good business plan.

The old saying is that “all it takes is one willing buyer and one willing seller to agree on the terms.” As important as the buyer’s motivation is to find the right property, it is just as important that the motivations of the seller are in alignment with the buyer’s. This is not to say that a seller is always “motivated” by positive forces, as it often happens that the investment plan that he or she had for the property have gone very much awry … and that is the focus of this article.

As exciting as it may be to buy an investment property, even the most experienced investors make mistakes. Here are a few ways to screw up:

Naivety — All too often and especially with new investors, an enthusiastic buyer will dive into the purchase of a property without doing his homework. It is important to get to know the local real estate market in the area the investor has placed his focus. For example, if the focus is in neighborhood retail centers, the buyer must know the neighborhood, including the surrounding zoning and governmental master plans for a wide radius. Learn if there are other centers in operation or planned in more strategic locations. Consider the leasing market by looking at lease and vacancy rates. In addition it is critical to understand the personal and financial commitments necessary to maintain the property in optimal condition.

Pride — While any investor should have pride in ownership, there is another kind of pride that often will cause a deal to go bad. If market conditions have changed to a point that your initial plan (if you had one in the first place) has been thrown off course and the recourses aren’t there to keep it on track, then maybe it is time to put the ego on the shelf and make the tough decision to cut your losses. Good business people know how to make such choices, while others can delay with concern that friends may see that things didn’t do so well. Believe it or not I’ve encountered many who have blindly hung for reasons like this without having the where with all to keep it together, only to painfully discover that things only got worse for their pocket books over time.

Greed — Some investors want a property to be a home run, even if it is not capable of such. Trying to soak an income property for every dollar of cash flow that can be squeezed out of it may work for a while. But all too often the end result will be that aspects of the investment will be sacrificed — be it maintenance or tenant quality. Over time these sacrifices will cause deterioration and a negative impact on cash flow and/or value.

Neglect – I have encountered many a landlord who acquires a property, blindly engages management, moves on to other things and then expects success by remote control. Well, sometimes that will work, but in such cases that’s more about luck. My experience is that there must be someone who keeps conscientious eye on all aspects of the investment, be it a well-chosen property manager or the landlord himself. I can offer up more examples in this case than any other, and over time the investment value really suffers due to poor maintenance, bad tenants, and high vacancies to name a few.

Emotion — One of my favorites. I’m sure at this point you can see that these all tend to be inter-related in one way of another, and typically if an investor suffers from one, it is not unusual for him to have the Full-Monty of these personal traits in full gear. But emotion is sort of the foundation of all of these traits. When investment decisions are made based upon emotion in contrast to that of a well thought out business decision, there is a high probability that something will not go well down the line.

So, whether you are a well-heeled experienced investor or new to the game, every economic climate offers opportunities.  However, without a strong business plan that has flexibility built into it to address all responsibilities of caring for your investment, you could fall prey to one of these five nasty traits and surely lose money in real estate.

The author: Rocky Mackintosh, President, MacRo, Ltd., a Land and Commercial Real Estate firm based in Frederick, Maryland. He also writes for TheTentacle.com and Want2Dish.com

The following excerpt is from CoStar news article by Randyl Drummer.

New accounting standards changes requiring companies to capitalize real estate and equipment leases on their balance sheets will not apply to commercial property owners and landlords.

“The International Accounting Standards Board (IASB) and the U.S.-based Financial Accounting Standards Board (FASB) signaled at their meetings Oct. 19-20 that they will exclude lessors and owners of investment properties from the proposed rules. The panels expect to issue a revised exposure draft of the lease accounting standard in the first half of next year, with adoption of a final standard targeted for the second half of 2012.”

Click Here to read the complete article.

The following excerpt is from The Washington Post news article by Steven Overly.

“The financial downturn left few corners of corporate budgets untouched, including real estate costs. Companies that reduce their overall footprint save on both rent and the amount of money paid to build out offices.”

Companies are redefining what the corporate office space looks like in order to maximize the space they have, while staying cutting edge and keeping employees happy.

Click Here to read the complete article.

The Wall Street Journal released the following news article by Kris Hudson on Sept. 7, 2011

With traditional retailers reluctant to renew or sign leases, landlords are embracing the influx of health clubs. According to real-estate research company CoStar Inc., health clubs and gyms accounted for 8.8% of new leases signed so far this year by retail chains in the U.S., compared with 7.9% at the same point last year. The rush into shopping centers has helped fuel a 57% increase in square footage occupied by U.S. health clubs since 2007, to more than 70 million square feet. MORE

MacRo renews commercial lease at Spring Ridge Shopping Center in Frederick, Maryland.

MacRo, Ltd., Real Estate Services is pleased to announce the renewal of New York J&P Pizza in the Spring Ridge Shopping Center, located at 6103 Spring Ridge Parkway.

New York J&P Pizza, which has a seven other locations throughout central Maryland, was one of the original tenants who MacRo, Ltd. placed in the 18,800 square foot addition the shopping center in April 2002.  The business occupies about 4,800 square feet.

With their retail commercial lease coming up for renewal, and the business having plans for extensive interior renovations, MacRo, Ltd. worked with the landlord and tenant to extend the lease into 2023.

Renovations are now complete.  The well established Italian/American restaurant continues to provide its customers with Italian specialties, including pizza, pasta and subs, as well as a full dinner menu and full bar.  In addition New York J&P Pizza offers a breakfast menu, carry-out and off premises catering.

MacRo, Ltd. has provided the owners of the Spring Ridge Shopping Center with full property management and commercial leasing services since the opening of the center in 2002.

Contact Rocky Mackintosh at 301-748-5655 or rocky@macroltd.com

In some sectors of the Commercial and Industrial leasing markets, landlords face unique challenges with existing leases.

This past week I received a call from a former client for whom we placed a tenant in a flex industrial condominium building about 3 years ago.

Having only this piece of investment real estate, the landlord chose to handle his own property management to save on costs, as he and his wife depended on every cent of the revenue for personal expenses.

Due to the economic downturn, about 18 months ago the tenant began to experience a dramatic fall in revenue.  At the same time, the vacancy rate in the industrial complex began to rise.

The tenant’s rent payments began to come in late, and after a few months the landlord made contact and inquired about the situation. The tenant stated that things were a bit tight, but was confident that his business was about to turn up for him in a “few months.”  Until that time came, he requested that the landlord defer the monthly pass-through charge for the real estate taxes and Common Area Maintenance (CAM) fees.  The landlord verbally agreed to this as well as a waiver of the 5% late fee.

However, after those “few months” instead of his business getting better, things got worse.  Even with the verbal agreement of deferred taxes and CAM, the tenant’s rent checks returned to a pattern of tardiness.

With the serious softening of the industrial flex space rental market, the landlord began to worry that he may loose the tenant in a climate of high vacancies. More discussions ensued with the tenant which yielded more concessions.  This time a verbal waiver of the annual 3% rent escalator.

Be that as it may, the promises continued that all deferred amounts owed would be made current when business bounced back… and the tenant insisted that was just around the corner .

Finally, at the point that the tenant was well into tens of thousands of dollars in sums deferred, the landlord thought it may be a good idea to seek some help. So I got a call.

He made it clear that with vacancies all around he didn’t want to loose the tenant, but at the same time he believed that he was being taken advantage of.

He asked for some advice and I gave him the following four tips:

1. Don’t go it alone: It is important to connect with your commercial real estate professional and ask if avoiding profession property management is/was really a wise call.  An important move is to engage a real estate lawyer to assist in the review of current circumstances with the existing lease, and drafting the terms of the revised documents.
2. Do a reality check: In times of high vacancies, leases executed in boom times may now be above market real estate value- which could mean a renegotiation of terms are in order. But things may not be as bad as they appear, so landlords must ask themselves whether it is the tenant’s problem or getting fair market return?
3. Identify your leverage: In any commercial real estate lease renegotiation it is best to deal from a position of strength.  Before you start giving a little here and some there, look at the big picture and possible outcomes. Review the existing lease terms- both your goals and the risks you are willing to take, the tenant’s situation and the climate of the real estate market. Use these points to recast a deal that is in your best interest, but fair to all concerned.
4. Get it in Writing: Even when a commercial real estate landlord allows the tenant to delay monthly rent payments they should get it in writing.  In this case, from the start, a deferral of real estate taxes, common area and even late fees should be acknowledged through an addendum and/or an interest bearing note with the appropriate guarantees.  It’s all about protecting what is legally yours. Verbal agreements in a commercial real estate transaction rarely carry much weight if things end up in court.

These are trying times for the commercial real estate leasing market. Landlords are finding that in order to avoid vacancies, renegotiating the terms of a lease will often yield a win-win outcome for both parties.

But, without professional guidance a landlord may discover that he may have renegotiated when it was not necessary or given away too much.

Rocky Mackintosh, President, MacRo, Ltd., a Land and Commercial Real Estate firm based in Frederick, Maryland. He is an appointed member of the Frederick County Charter Board. He also writes for TheTentacle.com and Want2Dish.com.

Third Quarter statistics show lease rate decreases and vacancy rate increases over same time last year.

Reis, Inc. recently released their September 30^th third quarter 2010 reports for commercial real estate properties.  This post will focus on some interesting stats from their Neighborhood Shopping Center 3rd Quarter 2010 Market Report.

The research firm defines a Neighborhood Shopping Center as “A shopping complex constructed around a supermarket and/or drug store as the only anchor tenant(s). It provides for the sale of convenience goods and personal services for the day-to-day living needs of the immediate neighborhood. The gross leaseable area typically ranges from 30,000 square feet to 150,000 square feet.” 

Out of 1,390,000 square feet of properties tracked in Frederick County, the average asking price per square foot fell from $17.97 per square foot to $17.56 over the last twelve months, which is a 2.28% fall. This does not include the typical proration for common area expenses, real estate taxes, etc.

On the other hand effective rent decreased from $16.40 per square foot to $15.49 over the last twelve months, which is a 5.55% fall.  Effective rent is defined as the average actual agreed lease rate (market rent), less the present value over the lease term of free rent, other extraordinary tenant improvements and concessions. 

It is also important to note that with the above being average rents, Reis does break down the asking rents for nonanchor tenants by age of the property, which shows a significant swing between $15.12 and $27.86.  So using the averages as a comparison factor can be very misleading.

Vacancy factors for neighborhood retail real estate are up on average from 7.4% in the 3^rd quarter of 2009 to 8.5% as of September 30, 2010.   This is actually a positive statistic when compared to the national average of 12.0%; however the 8.5% figure is slightly above the average vacancy rate for the Maryland suburbs around DC which sits at 8.1%.  All these figures are as much as 75% to 100% higher than the five year annualized averages.

The combination of the increase in the vacancy rate and the decrease in average lease rate can be attributed to tenants leaving and new tenants filling vacancies at a lower rate; however a reasonable percentage of the decrease in lease rates can also be attributed tenants approaching their landlords at renewal time (or somewhere in between) to request a reduction in their monthly lease payment.  We have found this to be the case in the commercial properties that the MacRo, Ltd. Property Management Department oversees.  Often a landlord would rather make a deal with the tenant to stay at a lower rent verses have to bare the risk of vacancy while seeking a new tenant in a difficult market.

Once again it is very apparent that the while Frederick County continues to feel significant pain from the existing real estate market slump, compared the national statistics we are weathering the storm reasonably well.

On a national scale the real estate market has been experiencing a continuous decline in values in just about all sectors since things turned in 2007– residential, rural, commercial, multifamily and industrial. 

There is one sector however that has recently seen a significant upswing in activity that should bode well for investors in the multifamily real estate sector. 

According to an October 15, 2010  Analysis of Third Quarter 2010 of the US Apartment Sector published through RIES.com, a leading provider of impartial commercial real estate performance information, activity during the third quarter shows “that recovery in the apartment rental sector appears to be firmly rooted. National vacancies fell by 70 basis points, from 7.8 to 7.1 percent … one of the sharpest drops in vacancy on record.” 

The report goes on to identify the causes to be tied to “pent-up demand from renters tired of living with their families or roommates … [and] flat or declining trends in housing prices and mortgage rates.”  As to latter many of those qualified to purchase a home seem to be concerned that housing prices will continue to fall.  So they would rather lock into a twelve-month lease for an apartment versus commit to buying a home and a 30-year mortgage. In addition many tenants are concerned about job security and would rather keep their options open.

At the local level here in Frederick County, while the region vacancy rate runs in the 6% range, the picture seems to be a bit more complicated to hold to that figure.  In recent interviews with a number of apartment property managers it appears that of class A and B projects over 200 units with rents over $1,200 per month struggle for stability, and have to offer a number of incentives to hold on to existing tenants and lure new ones to their units.

On the other hand class A and B projects that are smaller – 50 to 200 units – with rents under $1,000 per month, occupancy rates are at or near 100%.  We also are finding that the demand has been strong and steady enough during the last quarter that incentives have been minimized or dropped completely with some projects even increasing a bit.

At MacRo, Ltd., we have been very fortunate our apartment portfolio currently running with near zero vacancies.  Visit our website to learn more about our property management services.