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Archive for the ‘Leasing’ Category
With vacancy rates decreasing and an economy that continues to improve, Landlords are feeling bullish on the Twin Cities commercial real estate market. Recently we conducted a survey with six prominent Landlords to get an understanding as to what their perspective is in the next 6-12 months. The questions asked were:
- Have you raised you rates?
- Do you plan to in the next 12 months?
- Any plans to build a new building on a speculative basis?
- How much free rent will be offered in 2014?
The results of the survey were along the lines of what was expected with one surprise. Two of the Landlords surveyed were predicting that free rent would go away in 2014. That would be the first time since 2000 that free rent was not standard in new leases.
Notes from Survey:
- Every Landlord expects free rent to decrease in 2014
- As mentioned above, two Landlords predict free rent will go away completely in some sub markets
- One Landlord expects to build spec in 2014
- Most will only build if the perfect site presents itself
- Four Landlords have raised their quoted rates, only 1 has no plans to, and the last has plans to start increasing them in 2014
- All six would only build 24’ clear and higher for industrial, none have plans for office or flex (single level office with low clear)
Most Landlords are raising their rates on office and industrial between 5-10%. The market for high clear industrial space is tight and there are more situations where Tenants are competing for space. Office still has plenty of space available however there are certain areas where it is tight. For example, Downtown Class A for large blocks of space is extremely tight. The Bone Marrow Group is looking for 200,000 SF with little to no options. They are now getting close to a build to suit near Target Field, which should break ground in 2014.
Rental rates have not increased in years and while Tenants never want their cost of doing business to go up, it really has been a long time since Landlords have seen an increase. It is hard to imagine that free rent will go away in 2014 however if the market continues to improve at the same rate, it very well could. The Landlord could have the upper hand in 2014 or 2015.
The one item that the Tenant almost always has in their favor is the high cost to replace them. When a Tenant moves from one location to another, the cost to re-Tenant is almost unavoidable. Down time, tenant improvements, and real estate fees are associated with finding a new Tenant and are expensive. That is not likely to change any time soon.
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:
- Capital Gains increase from 15% to 20% for income earners over $400,000 for individuals and $450,000 for married folks
- 15 Year Qualified leasehold improvement deprication extended for 2 years retroactively from Jan 1, 2012 to Jan 1, 2014
- New Markets Tax Credits extended- http://en.wikipedia.org/wiki/New_Markets_Tax_Credit_Program
- Treatment of carried interest as capital gains left unchanged- http://en.wikipedia.org/wiki/Carried_interest
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.
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
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