“Economics is a subject that does not greatly respect one’s wishes”

-Nikita Khrushchev

For the last several months I have had the same conversation every day with my commercial real estate clients. It basically goes something like this:”Are things really as good as they look?” and “How long will the good times last?”

Anybody who was actively involved in brokering, lending, developing, investing or speculating in commercial real estate from 2008 onward knows how devastating the Great Recession was. In most markets nationally, and certainly here in Sioux Falls, SD, the fear is gone and business decision-making has resumed. My clients are making money again and 2008 – 2010 is a night terror partially forgotten in the daylight.

Despite the overall general good feeling, the specter of storm clouds threaten on the horizon. The stock market is volatile, Ebola dominates headlines, and Canada just got its first taste of domestic terrorism on its soil this week. Despite the echo chamber of the 24/7 media news cycle, things are good and they will stay good for another couple of years.

Here are some reasons why we have at least 2 to 3 years of sunshine to make hay in commercial real estate:

1) Lower Fuel Costs. Unless you are a gas station or a highly levered fracker (Forbes Article) in the Bakken Shale, paying less for gas means more money to spend on other things. The businesses that provide consumers with goods and services pay less too, allowing increased profits to be reinvested or distributed to investors/owners. According to a recent Wall Street Journal article, the US produced 8.5 million barrels of oil per day in July. It’s no longer news (Bloomberg article) that American advances in crude and natural gas extraction have catapulted the United States past Saudi Arabia and Russia to the top slot in global production.

As the United States continues to produce more supply and provide downward pressure on global prices over the next several years, look for a sustained drop in energy costs. Less money spent on energy frees up discretionary spending for both consumers and businesses.

2) Low Interest Rates.  Inflationary readings remain low (International Business Times Article). This allows central banks to maintain low or easy money interest rates. Cheap money encourages growth and spending.

According to the Congressional Budget Office’s August Update, the 10-Year Treasury Notes (key rate for commercial real estate debt) will slowly increase from 2.4% to 4.2% in 2017. That’s three years of low interest rates. Nice.

3) Recovering Job Market. The September Jobs report included a 5.9% unemployment rate (New York Times Article). Wow. That’s great. Do we have a wage growth problem? Yep. Is this percentage affected by a labor participation issue? I think so.

The good news is that people are going back to work. As more people go back to work and normalize their spending patterns the better off the general economy will be over the next two years.

If you would like to talk about your commercial real estate or real estate investing plans give me a call:

Nick Gustafson

605-201-2809

nick@benderco.com

“Most people will not put in the time to get a knowledge advantage.” -Mark Cuban

10 years ago I was new to the commercial real estate business. After grabbing my college diploma, getting licensed, leasing a new car, and spending precious money on a new wardrobe to look halfway presentable I hit the streets looking for commercial real estate deals. While I pounded pavement, during off hours I would pour over commercial real estate books. It seemed as if every book I could get my hands on was written for a first time investor, property manager, or someone other than a green commercial real estate broker.

Then I stumbled across Negotiating Commercial Real Estate Leases by Martin I. Zankel. Check it out on Amazon here: http://amzn.to/1FmEWs6. This was a nugget of gold in a sea of dross. It was about 250 pages of commercial lease advice written by a broker turned lawyer. I stumbled across my copy today and it’s well worn and beat up from rereads and reference. Lots of the material went over my head in those early years but I would repeat its wisdom in client meetings and conference calls with conviction. Enough people believed me as I started to broker increasing numbers of office leases.

Here are three takeaways that have helped my clients and might help you too:

1) Controlling the lease document.

Zankel’s first gem of advice is to “GET CONTROL OF THE LEASE DOCUMENT. The party who controls the drafting of the lease document will win all the small battles.”

Great piece of advice, especially in dealing with smaller landlords or business owners that begrudge every dime spent on attorney lease review. Simply offering to draft the lease or submit a copy during the initial offer gives a tenant or landlord tremendous advantages during lease negotiation and review.

2)  Including caps on expenses.

The idea of limiting expenses on tenant or landlord responsibilities was a new concept to me years back and occasionally I will introduce caps during certain situations depending on the situation.

3) Landlord Clauses

Appendix II contains an impressive list of landlord clauses to review and potentially draw from. A simple read is a must, a through understanding makes you sound like you know what you are talking about.

This was and is a great book for tenants, landlords and broker’s to read and absorb valuable takeaways from.

If you need help negotiating your next lease, you can reach me at:

Nick Gustafson

605-201-2809

nick@benderco.com

For the last 12 years or 14 seasons American Idol has captivated millions of viewers around the world and jump started genuine music careers. The concept is simple: throw a nationwide singing audition, tens of thousands of people show up, producers and judges hold progressive cuts to discover the newest American Idol. Drama ensues.

Something interesting occurs every season. The show actually finds talent.Carrie Underwood, Kelly Clarkson talent. Since Carrie Underwood’s 2005 win on the show she has sold 16 million albums, 30 million singles and made $100 million in tour revenue. Before her American Idol audition, Carrie was attending Northeastern State University in Oklahoma, waiting tables, working at a zoo and vet clinic.

Good for Carrie Underwood. What does this have to do with Real Estate Investing?

The Show American Idol is a numbers game. Every wannabe singer with a dream and the inclination to show up to audition displays talent. Producers get to pick and choose.

Here are some American Idol lessons that can make you money in Commercial Real Estate investing:

1)  Define Your Criteria.

• American Idol producers don’t let just anybody audition. They restrict their auditions to contestants ages 15 – 28, and have general rules regarding representation, and criminal backgrounds. This ensures that the show is focusing on the most marketable talent.
• If an investor focuses on single tenant retail investments ranging from $1,000,000 to $1,500,000 with at least 7 years of lease term and investment grade credit, suddenly patterns emerge and genuine deals stand out.

2)  Look at a Lot of Deals.

• Tens of thousands of people audition for American Idol. The best talent rises to the top.
• Warren Buffet once said that “The stock market is a no called strike game. You don’t have to swing at everything–you can wait for the right pitch.” Wait for the right pitch. If you look at a lot a pitches you will know when to swing.
  

Last month I had a meeting with a successful Sioux Falls business owner. Business is booming, he’s hiring and in danger of outgrowing his space before his lease ends in the near future.

1)   Not checking with the city regarding planned street improvements.

Most cities will resurface, improve, or significantly change busy thoroughfares at some point. These changes will clearly affect retail or personal service providers more than heavy industrial users, but keep in mind that a new median in a light industrial area can significantly change the way trucks and semis access even an industrial property.

Road construction can easily last a full spring or summer. A small retail business can easily get crushed during the 3 or 4 month period access is restricted to their customers.

The solution to this is spending the time to check with the city’s engineering office about upcoming traffic disruptions. The hour spent at the City prior to making an offer is well worth the thousands of dollars of potential business disruptions.

2)    Not buying a building that allows for growth

A result of a successful business is often the need to grow floor space, storage, production area, etc. Buying a building that does not have enough dirt or ability to expand in some way can be a bottle neck for continued growth. Commercial property usually takes some time to sell for full market price, so keep in mind that any building purchased may stick around for awhile.

To avoid this trap, be sure to buy a property that has less than a 1 to 5 building/land ratio for expansion. Another solution is to buy a property that has or could have an additional tenant sharing the building. The additional rent will support the building payments while you grow. As lease(s) expire, expansion is an option.

3)    Not putting enough equity into the deal.

This mistake is harder to do today with the recent recession fresh in lenders’ minds. However I encourage owner occupants to put as much equity into the deal as possible to provide a good margin of error. While the general economy probably will not blow up in the next several years (we hope!), remember that certain industries are dealing (or will deal) with paradigm shifts and new competitors. Sometimes having strong balance sheet is the best way to buy time for adaption or addition of new products or services to maintain profitability. Crushing principle and interest payments don’t help a business in transition.

Flood Plain Calculus

Let’s get one thing straight right off the bat. I’m not a flood plain expert. One of my partners (whose name rhymes with doghouse – which is usually where I am in his book) knows more about flood insurance than anybody I’ve met. Here are the highlights he has drilled into me, and things I have picked up along the way.

• FEMA drew its first Flood Insurance Rate Maps (FIRM) in Sioux Falls in 1979. Then redrew in 1982, 2009 and then again in 2011.
• Fact: More than a few investment/commercial buildings in Sioux Falls are now in the flood plain. When these buildings were built they were not.
• Section 42 of U.S.C 4012a sets the responsibility to place flood insurance on the applicable lender. In reality this means insurance agents must get a flood insurance policy pre-approved before a lender will close a transaction. (Really this means your commercial real estate broker will frantically make calls to any insurance agent who returns calls to get bids to ball park this number (Yes, it really flows downhill).
• Basically if a commercial property is in the flood plain and it has debt the federal government requires the lender to force the buyer to buy a flood insurance policy.

Who Cares?

If you are buying a commercial or investment property in Sioux Falls you need to determine if the property is in the flood plain early in due diligence. Properties that currently do not have debt on them, are in the flood plain and currently do not have insurance can be difficult to insure, and perhaps quite costly.

True Story

I sold a half million dollar office building this summer that was in the flood plain. It did not have debt or flood insurance on the property. Quotes ranged from $1,700 to $30,000 a year from various agents in town. We got the deal closed after a diligent agent from Howalt-McDowell took the time to work on the project (Thanks Karen!) and finally got a reasonable quote.

This delayed our transaction and almost killed the deal.

Take Away

You don’t have to be a flood insurance expert while buying your next property, but here are the basics.

• 1.       Determine through your insurance agent if your property is in the flood plain.
• 2.       Get a couple of quotes very early in due diligence.
• 3.       Factor this into your expenses much like property taxes. You can’t avoid it and the annual cost will most likely keep going up.