Despite a wary economy that has many businesses waving the yellow caution flag, commercial real estate professionals say they are doing deals that are adapted to the economic conditions. In making decisions about physical space, perhaps the first question to answer is whether it is better to buy or to rent. Although every aspect of the business must be considered in making this decision, it often comes down to personal preference and comfort level. “The type of buyer determines whether to buy or to lease,” said Ken Stark, president of Ken Stark & Associates in Reno. However, the rent or buy decision process has become more difficult in recent months because of the economic downturn and tightening of credit. “The market has changed dramatically in the last 12 months,” explained Tom Stilley, senior vice president of the office division of Colliers International in Las Vegas. “Those (buyers) who were perfect candidates then might not be now.”
Who is Buying?
Although each business has its own specialized needs, certain characteristics carry a higher weight in determining whether it might be more prudent to purchase an existing space or to lease. Businesses that typically purchase space fall into the category of having a stable history, have a strategic plan in place, do not require flexibility in their location and are financially sound. “Those that look to buy are established businesses that have a track record and have determined their long-term growth,” explained Dean Krieger, managing partner of Lee & Associates in Reno. With a strategic plan in place that forecasts expected growth, these businesses are more likely to purchase space that will serve them well in the future. A start-up without a track record would be taking a risk in purchasing property without knowing its needs for future expansion and flexibility.
Other businesses that find it attractive to purchase are those who need facilities that are particularly suited to them. “Some of those who buy are larger regional companies who are in manufacturing or distribution or service businesses where they have special long-term needs,” said Vic Donovan, executive managing director/principal of NAI Las Vegas. Examples include food distributors, call centers and light manufacturing. Companies that are going to be in one location for an extended period of time, who plan to install lots of equipment and make a large number of capital improvements are also prime candidates for purchasing property, according to Kevin Sigstad, broker and president of Premier Properties in Reno.
Another category of business that is likely to consider buying property are professionals such as accountants, doctors and attorneys. “Medical and professional type people typically like to own,” said David Flynn, senior vice president at Lee & Associates in Las Vegas. Much like owning a home, purchasing the physical site of a business can add a feeling of stability and worth to the enterprise. “A lot of sales are for medical facilities that want to have their own identity,” said Chuck Witters, senior vice president of Lee & Associates in Las Vegas.
In making the decision to buy, however, the rubber meets the road when the numbers are crunched. A business must have good credit and the ability to get a loan, such as from the Small Business Administration, in order to even consider purchasing property. “From the lenders’ prospective, there’s money out there for owners that have a good credit history,” Stark said. Tighter regulations in the lending business have made it more difficult for businesses lacking good credit to get loans, however. “It was so easy to get money before. There’s a lot more scrutiny in the way appraisals are done (now),” Stilley said.
Those who qualify for funds are in the enviable position of being able to take advantage of what is considered a buyers’ market because of falling prices. “For somebody who can put down a large down payment, there are great deals out there,” Stilley said. Although interest rates have crept up, a drop anywhere from 10 to 20 percent in the purchase price, depending upon the location, has made some deals very attractive. “There is a lot of opportunity now because people are in trouble with properties which creates opportunities for somebody with cash,” Flynn said.
Advantages and Disadvantages of Owning
Businesses that ultimately decide to become property owners enjoy a number of advantages. First, they know what their costs will be from year to year, especially with a fixed-rate loan, rather than having to worry about lease payments that will increase over time. They may have the opportunity to eventually sell the facility at a profit depending upon whether the market is appreciating or not. Lastly, they have a sense of pride and identity in owning their physical location.
Before leaping into the role of property owner, however, it is prudent to understand the potential disadvantages. Purchasing involves a large upfront cash outlay that includes the down payment and additional costs such as appraisals, building inspections and loan fees. On a building that sells for $1 million, for example, these additional costs could run into hundreds of thousands. Another disadvantage is the tax consequences of commercial property, where owners are only allowed to depreciate its value over 39 years while businesses that rent can write off the full amount each year.
Forecasting future growth can be somewhat tricky depending upon the type of business and its age. An overly optimistic forecast can put a business in too much space, which might cause it to lease out part of its building. An excessively pessimistic outlook might require the business to find additional space or to relocate before it is financially advantageous to do so. “The problem with owning is if you outgrow your business you don’t have the ease of going to a larger location,” Sigstad said. Some businesses might fail to realize that purchasing a building causes the owners to become real estate investors and, in some cases, landlords, which may or may not be roles they are comfortable with. “Some companies just don’t want the headaches of owning property,” Donovan explained. With the return on money in the five to six percent range, many companies are reluctant to tie up large sums that they believe might be more wisely invested elsewhere. “We find that larger corporations will not own their property because they can use that money more effectively in their business,” Sigstad explained.
Who is Leasing?
According to commercial real estate professionals, approximately two-thirds of clients are leasing versus the remaining one-third who are purchasing their physical locations. It’s obvious that the majority of businesses, large and small, have found that renting is the preferred way to go. “Most small businesses lease. It has to do with people wanting to keep costs low, such as start-up costs. Leasing is always good because it allows you to lay out a pretty clear cut strategic plan to grow,” Donovan said. Leasing also enables a business to rent space that they couldn’t afford to buy, such as in a luxurious high-rise building. “Lease tenants are the corporate America type who normally don’t buy,” Witters said. “On the local level the larger firms and more successful people will go into Class A buildings with a first-right-of-refusal in order to grow. They want the image of being in a Class A building.” For many businesses, the decision to lease is based largely upon their financial condition. “Overall it’s much better to lease than to purchase in this market. Lease rates are coming down by 5 cents a square foot from last year,” said Clint Steele, an associate with Lee & Associates in Reno.
With more than six million square feet of vacant office space in Las Vegas and a gross absorption rate that is expected to be only one-half in 2008 what it was in the past several years in the Reno/Sparks region, the market for leasing definitely favors potential tenants.
Vacant space abounds and in the current economy it affords attractive leasing deals for those who are appropriately positioned to take advantage of them. “A lot of lease concessions are being offered, such as free rent and more tenant improvements,” Stilley said.
Advantages & Disadvantages of Leasing
The advantages of leasing are appealing to many businesses and include the following:
• Less initial cash outlay
• Flexibility to make space fit needs of business as it changes
• Ability to deduct rent from annual taxes
• Opportunity to take advantage of owner provided tenant improvements
• Freedom to concentrate on primary business rather than the hassles of property ownership
Before signing a lease agreement, however, it is useful to at least be aware of the potential disadvantages. Since lease agreements are for a specified period of time, their expiration can cause an increase in rent, especially in an appreciating market which can be detrimental to the tenant business. Also, even though most property owners are flexible about providing tenant improvements to suit the prospective occupants, they may not be able to satisfy businesses that have very specific requirements. The business may move in only to find out the space is either unworkable or that its deficiencies impacts their bottom line in a negative way.
Finally, for those entrepreneurs who are always on the lookout for ways to make money, leasing can create missed opportunities to profit from the appreciating value of a facility they might have purchased.
Adapting
Although commercial real estate professionals say they’re still conducting transactions, the pace has changed and the number of deals has decreased. “There are fewer transactions happening across the board,” Krieger said. “Clients have a pretty good understanding of their business so we just put the facts in front of them.”
The biggest enemy in today’s economy is uncertainty which is reflected in the amount of time that it takes to consummate a transaction. “What is distinctly different between the market of today and several years ago is that the deals take longer and lots more details are provided. People want to make sure the decision is right,” Donovan said. “A few years ago, in the days of easier money, the deals went down much faster with a client just saying, ‘Let’s do it!’”
Because a loss of confidence in what the future might bring, many business owners put a premium on remaining agile enough to take advantage of other deals that might come along. “They want more flexibility to make sure they aren’t painting themselves into a corner,” Donovan explained. Some business owners are reluctant to make any changes until after the November election when the direction of the economy is expected to be more known. “Some people have a vision, but don’t want to pull the trigger yet. People are nervous about getting paid by their clients and they don’t want to increase their risks,” Steele said.
The Prospective
Forever the optimists, commercial real estate professionals look for niche opportunities to serve their clients in the future, despite acknowledging the probability of a continued downturn in the economy for at least the next few quarters. Northern Nevada looks to recruit clients from the Bay Area where increased absorption following the dotcom crisis years ago has decreased vacancy rates in recent months. “I think we’ll see some biotech, financial services and high tech people relocating in the next year,” Stark said.
Southern Nevada relies on the creation of thousands of jobs when new casino/hotel projects come on line next year. The increased demand for housing will hopefully have a ripple effect to help turn the economy around. Donovan expects that things will begin to change around the end of the first quarter of 2009. “This time next year you’ll definitely see a difference,” he said.
