Will Southern California’s empty warehouses find tenants? – Orange County Register

Much of my time is spent counseling family-owned and operated manufacturing and logistics providers.

My role is that of a trusted adviser but ironically, I’m not paid like other advisers such as CPAs and attorneys whose services are billed by the hour.

Commercial real estate professionals are paid by transactions. No deal, no paycheck. Many have asked why I have approached business this way for nearly four decades.

To me it’s simple. If I focus on the payday rather than the advice, I become a commodity. If a premium is placed on my counsel, a relationship is formed. I become less transactional and more oriented toward the long term.

Fortunately, some companies I encounter need to immediately lease or buy a location or find an occupant for a vacant one. But many times I’ll spend years working with a client before my brokerage services are employed.

So, what advice am I giving these days? Please indulge me as I share a few examples.

Watch the market

As discussed previously, since the halcyon days of 2021 and early 2022 — when space was being gobbled like a pizza on grad night — the leasing and selling pace has slowed.

There’s no better example than what’s occurring in Class A industrial offerings.

In 2021, any new construction brought to market was pre-leased before it was completed. Once the walls were tilted, the activity commenced. Once the roof was on, the lease was signed. Now, we have several concrete boxes waiting for occupants. Many more will follow this year.

Interesting is the activity in “less than Class A inventory.” Aging buildings suffering from substandard fire protection, compromised loading or ceiling heights that don’t allow for maximum stacking are finding favor because they’re 25% cheaper than their Class A cousins.

My advice: The fish are there, you just have to go a little deeper. Read: Lower asking rates.

How to combat rent increases

Tenants are choking on massive rent increases now and over the past three years.

This may sound contrary to the previous paragraph. You might be thinking, “Hmmm, I thought he said rents are coming down.” Both are true. Here’s how.

Let’s say you leased a 100,000-square-foot facility in 2018. The prevailing rates of that time were around $1-$1.25 per square foot. For easy math, that’s $100,000 per month in rent.

Most leases have annual rent escalators built in. In 2018 we were writing deals with 2.5%-3% annual bumps. So. That $100,000 you paid initially became $112,550 or $1.12 per square foot for the fifth year of the lease.

The last flurry of deals happened at over $2 per square foot or $200,000 per month, a whopping 77% increase!

If you’re facing renewal time, you encounter these crazy new rates. Today inventory is sitting. No one is dealing at those $2 rates. They’re compromising by leasing a location with fewer amenities — because they can. In 2021, such locations weren’t available. Now they are.

Advice: Don’t jump at that first offer your owner makes. Understand things will further soften until all this new stock is filled.

If you sell the engine, you’re left with the vehicle

For operators who make a decision to own vs. rent, a different challenge emerges.

We see countless examples of the real estate value eclipsing the worth of the enterprise. The most extreme case we’ve witnessed was tenfold. Yes, the address that houses the operation was worth 10 times more than the business.

We also found the operation had its rent subsidized. A real conundrum existed. Part of the benefit of owning the building from which your business operates is you can charge any rental rate you want — within reason. The lease payments are deducted by the business as an ordinary business expense and the owner of the building get monthly payments.

These lease payments are a ding on profit. If the rents are subsidized – or not at full market value – an unreal picture of the business’s profitability is painted.

Should these rents be “marked to market,” the value of the enterprise declines because the multiple of the EBIDA returns a smaller amount. By the same token, if the business is not paying full market rental value, then the value of the real estate is understated. So what’s a mother to do?

Advice: Ratchet up that rent.! If the company can’t afford it, maybe it’s time to seek cheaper quarters.

Excess space is challenging

If you find yourself with space you don’t need, you have four alternatives to rid yourself of the excess.

You can approach the building owner and ask him to let you out of your lease or you could propose a buyout of the remaining obligation of your lease. You also could find a sub-tenant who will take over your lease. Or — and we never recommend this alternative — you could simply stop paying rent and cause your lease to go into default.

Because many of the leases written over the past two years are over-market today, that alternative is a non-starter.

Most find the amount needed to buy out their remaining obligation is too hefty. Unless you’re an unfair dealer, four is out. So subleasing is left. Advice: Your goal should be to minimize the amount of time you continue to pay rent. In other words, find a replacement as soon as you can. Understand you are limited in what you can offer to the market in the way of tenant improvements and a term exceeding that of your of your lease. The best way to make a sublease space attractive to a perspective occupant is to trim the rate by 25 to 30% and hit the market with shock and awe.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.