Conversation with a private real estate investor reveals hurdles ahead

Investors in commercial real estate come in different shapes and sizes.

As you might recall, I define an investor as one who relies on the rent an occupant pays for her livelihood. Institutional, public or private investors have in common this requirement: a paying tenant.

You may be wondering if investors ever buy a vacant building? Sure, but trust me. They understand the time and expense necessary to originate a tenancy. If they miscalculate, there goes the return on their invested dollars. And this loss can never be recouped.

Recently, we were engaged to assist a private investor to redeploy proceeds from the sale of another piece of commercial real estate. He’s deferring the gain through the use of a 1031 exchange.

If you’re unfamiliar with an exchange, here’s a brief description. A seller transacts and the proceeds are placed with a qualified intermediary. The clock starts. A replacement must be identified within 45 days and purchased sooner than 180 days from close or the filing date of next year’s tax return. An equal amount of dollars and debt must be spent on a like-kind income property (or properties). If orchestrated correctly, the income taxes on the gain are deferred. Sounds simple. But please consult your tax, accounting and real estate professionals before undertaking.

Last week, we toured a couple of alternatives and I believed our conversation was column-worthy.

While his sale property was in escrow, we spent a couple of meetings discussing qualifications for the buy. What emerged was a desire to acquire a single or dual-tenant industrial building with a triple net lease. The return should be north of 4.5% and should provide a reasonable remaining lease term. Credit of the tenant is important and the rent being paid should be at or below market.

First on our list was a single-tenant property that could be divided once the tenant vacates. Currently, the building is occupied by the owner who is moving out of state. Because his new business home is not yet completed, he is looking for a short-term lease back of a year to 18 months.

After the first property visit, we looked at option number two. The occupant of the building was once owned by the owner of the building. We frequently see this when a business owner decides it’s time to cash in the chips but sees merit in retaining ownership of the real estate.

In this case, it’s now time for the owner of the real estate to move her money into a more tax-friendly state, therefore her motivation to sell. Encountered was an operation that has a significant amount of money invested in the infrastructure of the building and 4 ½ years remaining on its lease. Located in an emerging area – but not quite mature – one could sense we were pioneering a bit.

So here’s what our client had to say about both alternatives.

He really likes the first building we looked at although he understands an amount of money for re-tenanting the building must be considered. After all, this will be addressed in early 2024. Our client was concerned that the owner of the building has time until his new building is completed and therefore might not be terribly motivated.

Additionally, the owner had unrealistic expectations of the property’s worth, especially based on the economic storm clouds we see massing on the horizon of inflation, rate increases and the threat of inflation. He’ll offer, but at well less than the asking price.

On to the wild, wild West. We discovered the owner of this building would like to carry a loan. If favorable terms can be negotiated, this could actually be a win. Because the property is located in a developing area, the term of the lease becomes critically important. Insufficient is the 4 ½ years that remain. Consequently, we will ask to have a longer-term at the close of escrow.

Ok, nets cast. Time to harvest the bounty of investor interest.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at [email protected] or 714.564.7104.