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Changing Commercial Real Estate Market | Twin Cities

by Chris Garcia, 3:37 PM on October 28th, 2013, No Comments

The commercial real estate market much like the stock market continues to improve.  Tenants are expanding their operation through lease expansions and building purchases.  The amount of absorption this year will be substantial.

As a result of all the positive news, the market is now aggressively changing.  We are seeing less free rent, higher rates, longer lease terms, and higher construction costs.  Below we have looked at some of the effects of the changing real estate market:

Trends of a Changing Market

Less Free Rent

It was common for the last few years to get 1 month free per term of the lease.  That has changed to ½ month per year of the term and rounded up; i.e. 5 year lease would be 3 months free.  However there are Landlords not offering any.  The amount will depend on the product type, amount of improvements, and credit of the Tenant.

Term Being Pushed

Landlords are pushing lease term.  3 and 5 year leases used to be the norm. Now it is 5 and 7 year leases.  10 and 15 year leases are not uncommon.  This trend will continue.

Rental Rates Rising

A fairly obvious trend of an improving market, Landlords are pushing the rates when they can.  Many are trying to make up for the last few years and looking for 10% increases.

Annual Bumps Increase

Annual increases are being asked up to 3-5% which is a far cry from the 2-3% which were seen from 2008-12.  Some Landlords were doing little to no annual increases, not the case any longer.

Tenant Improvements Increase

The cost to build out space is once again on the rise.  Any General Contractor will tell you that their margins were squeezed from 2008-12.  For a retro fit of an existing office, a minimum of $15 per square foot will be needed and $30 per square foot for a higher quality space (carpet tile, moving/building new offices, higher end finishes).

The real estate market, like any other continues to change.  At this point in time it is moving in the direction of the Landlord with less quality space available.  There still are subleases available and motivated Landlords as well as buildings available for sale.

The Fiscal Cliff- What It Means to Commercial Real Estate

by Chris Garcia, 6:08 PM on January 3rd, 2013, No Comments

Now that the Fiscal Cliff has been averted and a new tax deal is in place, there will be several implications to those that lease or own commercial real estate.  That pretty much covers all of the business world.  Below is a quick overview:

The 2 that will have the biggest impact for Landlords and Tenants are Capital Gains and Leasehold Improvements.  Those two items for most, will stay the same for the near future but could change at some point particularly the leasehold improvement depreciation schedule as it expires Jan 1, 2014.

 

 

5th Street Towers Sold at Sheriff Sale

by Chris Garcia, 10:18 AM on September 5th, 2012, No Comments

In May of this year Zeller Properties and Invesco Real Estate purchased the 5th Street Towers at Sheriff Sale for $110M or $103 per square foot (PSF).  The price paid was $1 higher than the next bidder, MetLife the debt holder.  This will be the most significant sale in 2012.  Here is the story:

Zeller initially identified the properties shorty after they sold in 2007 as it sold for a high price and subsequently lost a large amount of Tenants, dropping occupancy to 72%.  From that point up until today the properties have not reached 80% occupancy.  The market is at 85% in comparison.   Clearly Carter Properties purchased the buildings at the absolute worst time possible as the recession hit just a year later.

With the prolonged recession, significant drop in rental rates, and increase in market vacancy, 5th Street Towers was doomed.  The only thing that could have saved the project was an injection of capital however with an extremely high basis price, the investors would then need to hold for 5-10 additional years with no guarantee that the buildings would stabilize.

Late last year the buildings went into foreclosure with the Sheriff Sale set to happen in the Spring of 2012.  The issue with purchasing property from a Sheriff Sale is that most of the due diligence items are not available.  Those items include:

  • Rent Roll- Lease information including size, rental rates, lease  expiration, and lease options
  • Property Inspection- HVAC, roof, elevator, structure, any other item that is sure to come up

Those are the two major items and neither were available to any potential Buyers.  With that, certain assumptions needed to be made.  Zeller did a number of items to understand the properties leases and condition:

  • Reviewed the old Rent Roll from 2007 when the properties were last available
  • Connected with Wells Fargo to understand their lease terms
  • Toured the properties and guessed at capital costs

It turns out the buildings did need substantial capital improvements including new HVAC, restroom upgrades, among the improvements.  However since the properties were purchased at such a low price, the improvements did not affect the investment.  Once the buildings reach a market vacancy rate they will provide significant upside for the investors.

Some interesting facts:

  • Buyers put debt on the buildings just 71 days after purchase
  • Zeller showed up at the Sheriff Sale with an additional $10M, in case someone bid higher than the debt
  • Currently have 2M SF of new lease activity

Future Value

The properties have 370,000 SF of vacancy (around 35%) according to the commercial MLS.  If the buildings were to reach 90% occupancy, essentially lease 260,000 SF of space at a rate of $15 PSF,  then the income would be around $14.4M with a carry cost of approximately $800,000.  That leaves a net operating income of $13.6M.

The value on the $13.6M is approximately $180M.  The cost to lease the vacancies will be in the neighborhood of $40 PSF or around $10M.  If all goes according to plan, the investment will look like this:

Purchase Price- $110M

Lease/Carry Costs- $10M

Total Cost- $120M

7.5% Cap Rate Value- $180M

Profit of $60M

Minneapolis Market Update April 2012

by Chris Garcia, 6:32 PM on April 10th, 2012, No Comments

The Minnesota Commercial Association of Realtors recently published their annual market report.  The market continues to experience positive absorption in both office (1.1M positive) and industrial (1.3M positive).  Vacancy rates are declining and rents are starting to increase.  Below is a summary:

Office- 1.1M positive absorption

Market Vacancy Rate- 16.2%

Minneapolis CBD- 14.3% (Class A 9.2%)

West Metro- 15.3% (Class A 10.3%)

St Paul CBD- 22.4% (Class A 15.9%)

Industrial 1.3M positive absorption

Market Vacancy Rate- 11.8%

Northwest Metro- 10.6%

Southwest Metro- 13.2%

East/NorthEast Metro- 9.5%

Office vacancy remains high while industrial is moving toward a healthy market.  Office is a direct correlation to the jobs market while industrial shows production and consumption is increasing.

6 Ways You May Be A Candidate For Lease Savings

by Chris Garcia, 11:34 PM on March 29th, 2012, No Comments

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6 Ways You May Be A Candidate For Lease Savings

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