Albert Einstein:           “Everything should be made as simple as possible, but not simpler.”

 

Commercial Real Estate Due Diligence – the Four Areas of Inquiry

I’m a big fan of Albert Einstein. He’s one of my intellectual heroes.  He could see and understand what others could barely imagine. His greatest gift, I believe, was his ability to find answers to questions others didn’t even know existed.

Real estate due diligence requires insight as well. To find the answers, you must

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This article is being republished as a welcoming salutation to many of my long-lost Real Estate Developer friends.  You have been missed over the past several years. Call me.  Let’s do lunch!

Did I happen to mention I love Real Estate Developers? Not like I love my wife or my kids, or even my dog, but Real Estate Developers are definitely among my favorite people.

Think about it.

Real Estate Developers are like Gods. [Well, miniature gods, at least.] They create much of the physical world we inhabit. The homes and condominiums we live in. The grocery store and pharmacy down the street. The resorts and casinos and golf courses we enjoy for leisure. Restaurants. Shopping centers. Office buildings. Movie theaters. Truck terminals. Medical and surgical centers. Spas. Factories. Warehouses. Auditoriums. Parking garages. Hotels.

You name it; if its man-made, attached to dirt, and we can get inside it, a Real Estate Developer was probably involved.

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Are you planning to purchase, finance or develop any of the following types of Commercial or Industrial Real Estate?

• • Shopping Center?
• • Office Building?
• • Large Multifamily residential?
• • Parking Lot/Parking garage?
• • Retail Store?
• • Mixed-Use?
• • Restaurant/Banquet property?
• • Sports and Entertainment Venue?
• • Intermodal Logistics Terminal?
• • Medical Building?
• • Gas Station?
• • Distribution Center?
• • Manufacturing facility?
• • Pharmacy?
• • Special Use facility ?
• • Other?

A KEY element to successfully investing in commercial or industrial real estate is performing an adequate Due Diligence Investigation prior to becoming legally bound to acquire the property. An adequate Due Diligence Investigation will assure awareness of all material facts relevant to the intended use or disposition of the property after closing.

 The following checklists will help you conduct a focused and meaningful Due Diligence Investigation.

 BASIC DUE DILIGENCE CONCEPTS

 Caveat Emptor: Let the Buyer beware.

Consumer protection laws applicable to home purchases seldom apply to commercial real estate transactions. The rule that a Buyer must examine, judge, and test for himself, applies to the purchase of commercial real estate.

Due Diligence:

“Such a measure of prudence, activity, or assiduity, as is proper to be expected from, and ordinarily exercised by, a reasonable and prudent (person) under the particular circumstances; not measured by any absolute standard, but depending upon the relative facts of the special case.” Black’s Law Dictionary; West Publishing Company.

Contractual representations and warranties are NOT a substitute for Due Diligence. Breach of representations and warranties = Litigation, time and $$$$$.

The point of commercial real estate due diligence is to avoid transaction surprises and confirm the Property can be used as intended.

 WHAT DILIGENCE IS DUE?

The scope, intensity and focus of any Due Diligence Investigation of commercial or industrial real estate depends upon the objectives of the party for whom the investigation is conducted. These objectives may vary depending upon whether the investigation is conducted for the benefit of: (i) a Strategic Buyer (or long-term lessee); (ii) a Financial Buyer; (iii) a Developer; or (iv) a Lender.

If you are a Seller, understand that to close the transaction your Buyer and its Lender must address all issues material to their respective objectives – some of which require information only you, as Owner, can adequately provide.

GENERAL OBJECTIVES:

 (i) A “Strategic Buyer” (or long-term lessee) is acquiring the property for its own use and must verify that the property is suitable for that intended use.

 (ii) A “Financial Buyer” is acquiring the property for the expected return on investment generated by the property’s anticipated revenue stream, and must determine the amount, velocity and durability of the revenue stream. A sophisticated Financial Buyer will likely calculate its yield based upon discounted cash-flows rather than the much less precise capitalization rate (“Cap. Rate”), and will need adequate financial information to do so.

 (iii) A “Developer” is seeking to add value by changing the character or use of the property – usually with a short-term to intermediate-term exit strategy to dispose of the property; although, a Developer might plan to hold the property long term as a Financial Buyer after development or redevelopment. The Developer must focus on whether the planned change in character or use can be accomplished in a cost-effective manner.

 (iv) A “Lender” is seeking to establish two basic lending criteria:

 (1) “Ability to Repay” – The ability of the property to generate sufficient revenue to repay the loan on a timely basis; and

 (2) “Sufficiency of Collateral” – The objective disposal value of the collateral in the event of a loan default, to assure adequate funds to repay the loan, carrying costs and costs of collection in the event forced collection becomes necessary.

The amount of diligent inquiry due to be expended (i.e. “Due Diligence”) to investigate any particular commercial or industrial real estate project is the amount of inquiry required to answer each of the following questions to the extent relevant to the objectives of the party conducting the investigation:

I. THE PROPERTY:

 1. Exactly what PROPERTY does Purchaser believe it is acquiring?

• Land?

• Building?

• Fixtures?

• Other Improvements?

• Other Rights?

• The entire fee title interest including all air rights and subterranean rights?

• All development rights?

 2. What is Purchaser’s planned use of the Property?

 3. Does the physical condition of the Property permit use as planned?

• Commercially adequate access to public streets and ways?

• Sufficient parking?

• Structural condition of improvements?

• Environmental contamination?

• Innocent Purchaser defense vs. exemption from liability

• All Appropriate Inquiry

 4. Is there any legal restriction to Purchaser’s use of the Property as planned?

• Zoning?

• Private land use controls?

• Americans with Disabilities Act?

• Availability of licenses?

• Liquor license?

• Entertainment license?

• Outdoor dining license?

• Drive through windows permitted?

• Other impediments?

 5. How much does Purchaser expect to pay for the property?

 6. Is there any condition on or within the Property that is likely to increase Purchaser’s effective cost to acquire or use the Property?

• Property owner’s assessments?

• Real estate tax in line with value?

• Special Assessment?

• Required user fees for necessary amenities?

• Drainage?

• Access?

• Parking?

• Other?

 7. Any encroachments onto the Property, or from the Property onto other lands?

 8. Are there any encumbrances on the Property that will not be cleared at Closing?

• Easements?

• Covenants Running with the Land?

• Liens or other financial servitudes?

• Leases?

9. If the Property is subject to any Leases, are there any:

• Security Deposits?

• Options to Extend Term?

• Options to Purchase?

• Rights of First Refusal?

• Rights of First Offer?

• Maintenance Obligations?

• Duty of Landlord to provide utilities?

• Real estate tax or CAM escrows?

• Delinquent rent?

• Pre-Paid rent?

• Tenant mix/use controls?

• Tenant exclusives?

• Tenant parking requirements?

• Automatic subordination of Lease to future mortgages?

• Other material Lease terms?

10. New Construction?

• Availability of construction permits?

• Soil conditions?

• Utilities?

• NPDES (National Pollutant Discharge Elimination System) Permit?

• Permit required if earth is disturbed on one acre or more of land.

• If applicable, Storm Water Pollution Prevention Plan (SWPPP) is required.

II. THE SELLER:

1. Who is the Seller?

• Individual?

• Trust?

• Partnership?

• Corporation?

• Limited Liability Company?

• Other legally existing entity?

2. If other than natural person, does Seller validly exist and is Seller in good standing?

3. Does the Seller own the Property?

4. Does Seller have authority to convey the Property?

• Board of Director Approvals?

• Shareholder or Member approval?

• Other consents?

• If foreign individual or entity, are any special requirements applicable?

• Qualification to do business in jurisdiction of Property?

• Federal Tax Withholding?

• US Patriot Act compliance?

5. Who has authority to bind Seller?

6. Are sale proceeds sufficient to pay off all liens?

III. THE PURCHASER:

1. Who is the Purchaser?

2. What is the Purchaser/Grantee’s exact legal name?

3. If Purchaser/Grantee is an entity, has it been validly created and is it in good standing?

• Articles or Incorporation – Articles of Organization

• Certificate of Good Standing

4. Is Purchaser/Grantee authorized to own and operate the Property and, if applicable, finance acquisition of the Property?

• Board of Director Approvals?

• Shareholder or Member approval?

• If foreign individual or entity, are any special requirements applicable?

• Qualification to do business in jurisdiction of the Property?

• US Patriot Act compliance?

• Bank Secrecy Act/Anti-Money Laundering compliance?

5. Who is authorized to bind the Purchaser/Grantee?

IV. PURCHASER FINANCING:

A. BUSINESS TERMS OF THE LOAN:

1. What loan terms have the Borrower and its Lender agreed to?

• What is the amount of the loan?

• What is the interest rate?

• What are the repayment terms?

• What is the collateral?

• Commercial real estate only?

• Real estate and personal property together?

• First lien?

• A junior lien?

• Is it a single advance loan?

• A multiple advance loan?

• A construction loan?

• If it is a multiple advance loan, can the principal be re-borrowed once repaid prior to maturity of the loan; making it, in effect, a revolving line of credit?

• Are there reserve requirements?

• Interest reserves?

• Repair reserves?

• Real estate tax reserves?

• Insurance reserves?

• Environmental remediation reserves?

• Other reserves?

2. Are there requirements for Borrower to open business operating accounts with the Lender? If so, is the Borrower obligated to maintain minimum compensating balances?

3. Is the Borrower required to pledge business accounts as additional collateral?

4. Are there early repayment fees or yield maintenance requirements (each sometimes referred to as “pre-payment penalties”)?

5. Are there repayment blackout periods during which Borrower is not permitted to repay the loan?

6. Is a profit participation payment to Lender required upon disposition?

7. Is there a Loan Commitment fee or “good faith deposit” due upon Borrower’s acceptance of the Loan Commitment?

8. Is there a loan funding fee or loan brokerage fee or other loan fee due Lender or a loan broker at closing?

9. What are the Borrower’s expense reimbursement obligations to Lender? When are they due? What is the Borrower’s obligation to pay Lender’s expenses if the loan does not close?

B. DOCUMENTING THE COMMERCIAL REAL ESTATE LOAN

Does Purchaser have all information necessary to comply with the Lender’s loan closing requirements?

Not all loan documentation requirements may be known at the outset of a transaction, although most commercial real estate loan documentation requirements are fairly typical. Some required information can be obtained only from the Seller. Production of that information to Purchaser for delivery to its lender must be required in the purchase contract.

As guidance to what a commercial real estate lender may require, the following sets forth a typical Closing Checklist for a loan secured by commercial real estate.

Commercial Real Estate Loan Closing Checklist

1. Promissory Note

2. Personal Guaranties (which may be full, partial, secured, unsecured, payment guaranties, collection guaranties or a variety of other types of guarantees as may be required by Lender)

3. Loan Agreement (often incorporated into the Promissory Note and/or Mortgage in lieu of being a separate document)

4. Mortgage (sometimes expanded to be a Mortgage, Security Agreement and Fixture Filing)

5. Assignment of Rents and Leases.

6. Security Agreement

7. Financing Statement (sometimes referred to as a “UCC-1”, or “Initial Filing”).

8. Evidence of Borrower’s Existence In Good Standing; including :

(a) Certified copy of organizational documents of borrowing entity (including Articles of Incorporation, if Borrower is a corporation; Articles of Organization and written Operating Agreement, if Borrower is a limited liability company; certified copy of trust agreement with all amendments, if Borrower is a land trust or other trust; etc.)

(b) Certificate of Good Standing (if a corporation or LLC) or Certificate of Existence (if a limited partnership) or Certificate of Qualification to Transact Business (if Borrower is an entity doing business in a State other than its State of formation)

9. Evidence of Borrower’s Authority to Borrow; including:

(a) Borrower’s Certificate

(b) Certified Resolutions

(c) Incumbency Certificate

10. Satisfactory Commitment for Title Insurance (which will typically require, for analysis by the Lender, copies of all documents of record appearing on Schedule B of the title commitment which are to remain after closing), with required commercial title insurance endorsements, often including:

(a) ALTA 3.1 Zoning Endorsement modified to include parking [although if the property is a multi-user property, such as a retail shopping center, an ALTA 3.0 Zoning Endorsement may be appropriate]

(b) ALTA Comprehensive Endorsement 1

(c) Location Endorsement (street address)

(d) Access Endorsement (vehicular access to public streets and ways)

(e) Contiguity Endorsement (the insured land comprises a single parcel with no gaps or gores)

(f) PIN Endorsement (insuring that the identified real estate tax permanent index numbers are the only applicable PIN numbers affecting the collateral and that they relate solely to the real property comprising the collateral)

(g) Usury Endorsement (insuring that the loan does not violate any prohibitions against excessive interest charges)

(h) other title insurance endorsements applicable to protect the intended use and value of the col- lateral, as may be determined upon review of the Commitment for Title Insurance and Survey or arising from the existence of special issues pertaining to the transaction or the Borrower.

11. Current ALTA/ACSM Land Title Survey (3 sets), prepared in accordance with the 2011 (or current) Minimum Standard Detail Requirements for ALTA/ACSM Land Title Surveys

12. Current Rent Roll

13. Certified copy of all Leases (4 sets – 1 each for Buyer, Buyer’s attorney, Title Company and Lender)

14. Lessee Estoppel Certificates

15. Lessee Subordination, Non-Disturbance and Attornment Agreements [sometimes referred to simply as “SNDAs”]

16. UCC, Judgment, Pending Litigation, Bankruptcy and Tax Lien Search Report

17. Appraisal -complying with Title XI of FIRREA (Financial Institutions Reform, Recovery and Enforcement Act of 1989, as amended)

18. Environmental Site Assessment Report (sometimes referred to as Environmental Phase I and/or Phase 2 Audit Reports)

19. Environmental Indemnity Agreement (signed by Borrower and guarantors)

20. Site Improvements Inspection Report

21. Evidence of Hazard Insurance naming Lender as the Mortgagee/Lender Loss Payee; and Liability Insurance naming Lender as an “additional insured” (sometimes listed as simply “Acord 27 and Acord 25, respectively)

22. Legal Opinion of Borrower’s Attorney

23. Credit Underwriting documents, such as signed tax returns, property operating statements, etc. as may be specified by Lender

24. Compliance Agreement (sometimes also called an Errors and Omissions Agreement), whereby the Borrower agrees to correct, after closing, errors or omissions in loan documentation.

* * * * *

It is useful to become familiar with the Lender’s loan documentation requirements as early in the transaction as practical. The requirements will likely be set forth with some detail in the lender’s Loan Commitment – which is typically much more detailed than most loan commitments issued in residential transactions.

Conducting the Due Diligence Investigation in a commercial real estate transaction can be time consuming and expensive in all events.

If the loan requirements cannot be satisfied, it is better to make that determination during the contractual “due diligence period” – which typically provides for a so-called “free out” – rather than at a later date when the earnest money may be at risk of forfeiture or when other liability for failure to close may attach.

CONCLUSION

Conducting an effective Due Diligence Investigation in a commercial or industrial real estate transaction to discover all material facts and conditions affecting the Property and the transaction is of critical importance.

Unlike owner occupied residential real estate, when a house can nearly always be occupied as the purchaser’s home, commercial and industrial real estate acquired for business use or for investment is impacted by numerous factors that may limit its use and value.

The existence of these factors and their impact on a Purchaser’s ability to use the Property as intended can only be discovered through diligent and focused investigation and attention to detail.

Exercise Due Diligence.

If you need assistance, please ask for help.

The Time to Decide – Commercial Real Estate Litigation

A sage once said, “The time to worry about where the ball will drop is before the wheel is spun”.  He was speaking about roulette, of course, but the wisdom of these words has much broader application.  The point is, worry about the outcome before you place the bet, when you can still do something about it.

Commercial litigation, especially commercial real estate litigation, is in some respects like roulette. Once your lawsuit is filed, the wheel is spinning.  Unlike roulette, you may still have a measure of control over the outcome — but you are in it until the ball drops. 

In CRE litigation there is seldom an insurance company prepared to write a check.  There is a substantial risk the case will proceed to trial.  There is no guaranty you will collect anything – especially if payment of money is not the relief you seek. Consequently, there is very little chance your attorney will accept your commercial dispute on a contingent fee basis. A third of nothing is still nothing. 

Lawyers handling commercial litigation are not your partners. Commercial litigators charge by the hour.  Except in rare cases where you can negotiate a hybrid fee arrangement, you will assume the entire financial risk – not your lawyer. Your lawyer is serving as your paid professional advocate; a hired gun, so to speak.

As long as you are willing and able to pay your lawyer to apply his or her skill and training to your cause, your lawyer is bound to represent you with zeal and vigor. If you do not pay, you should expect your lawyer to stop work.  The fact that the practice of law is a profession does not make it a charitable enterprise. It is both a profession and a business.  There is no moral or ethical imperative for a lawyer to work without pay while advocating a commercial dispute.  CRE litigation is business litigation – and the business being advanced is yours.

I am not a big fan of commercial litigation. It is expensive for my clients and distracts them from their core business.  It is in their core business where they make money.  It is because of their core business that I am their lawyer.  Still, if you are going to litigate, then commit to litigate. Do not file a lawsuit unless you intend to see it through and win.

If you know anything about law firm profitability, it may surprise you to hear me say I am not a huge fan of litigation. Lawsuits can be very profitable for lawyers. Lawsuits are labor intensive and can take on a life of their own.  Huge legal fees can be run up in a hurry.  If that is how you determine to spend your money then, by all means, call me.  My law firm has an outstanding group of litigators.  In commercial litigation, including CRE litigation, we combine our transactional knowledge with litigation prowess and are unsurpassed. I just think you ought to make an informed and seriously calculated decision before you decide to spend your money in this way.

It is virtually impossible to predict with accuracy how much a lawsuit will cost.  Typically, it will cost much more than you imagine. This is because, unlike a business or real estate transaction you can choose to walk away from if it ceases to make economic sense, lawsuits, once filed, are not so easy to escape.  It’s like choosing to dance with an 800 pound gorilla.  As the joke goes, “When do you stop?  When the gorilla decides to stop.”  Once you have filed a lawsuit, or have taken a position in a dispute that will lead to your adversary filing a lawsuit, you have reached the dance floor and may very well find yourself cheek to cheek with an 800 pound gorilla.

Don’t get me wrong.  There are times when litigation is necessary and appropriate.  There are times when an adversary is so brazenly interfering with your business or trampling on your rights and interests that the benefits of litigation will far exceed your costs.  There are times when litigation is your only reasonable choice. 

In making the decision to proceed, however, understand the tangible and intangible costs.  Attorneys’ fees may run into tens of thousands of dollars, and in a complicated case perhaps even into the hundreds of thousands of dollars. The litigation may also distract you from your core business and subject you to significant emotional strain and sleepless nights.  Do not underestimate these add-on intangible costs. 

If you are going to litigate, be sure to hire a  lawyer experienced in the type of litigation you intend to  pursue.  Litigation strategy is based on game theory.  Each move you make must anticipate your adversary’s next several moves. Your strategy and its implementation must be designed to win and be agile enough to adapt to changing circumstances if your adversary moves forward in an unanticipated way.  Knowledge is power.

Part of what makes litigation emotionally draining is a lack of understanding about how the process works.  It is not as mysterious as clients sometimes seem to believe.

The bones of litigation are this:  You and your adversary are in disagreement. You are convinced your position is superior.  Your adversary is convinced its position is superior. You are unable to reach a compromise that works for you both.  Filing a lawsuit is a decision to let someone else decide. 

The litigation process is a process of gathering useful information to support your position and to undermine your opponent’s position. Your adversary is engaged in the same process. Some of this information is applicable law. Much of the information is supporting facts. Ultimately, you will each present your compiled information to an independent decision maker.  A judge or jury will decide.

If you are going to litigate, the decision to do so should be based upon a sober determination of the benefits likely to be achieved, the costs of obtaining those benefits, and your likelihood of success.  You may have the greatest case in the world; your lawyer may tell you it will be a “slam dunk”; but if it is going to cost you more than you reasonably expect to gain – measuring both tangible and intangible costs – at least consider the choice of not proceeding. The decision to proceed or not to proceed is yours. It is very much a business decision.  

In making the decision to litigate, use the same skills of economic analysis you use to make real estate investment decisions. If you know it will cost you $2,000,000 to develop and market a project, but your likely return is only $1,500,000, would you proceed?  If your disputed claim is for $50,000 but it will cost you $60,000 to $100,000 to collect, should you proceed?  The answer may depend upon other factors as well but, all else being equal, the rational economic choice is obvious.

Too often lawsuits are filed as an emotional response to a perceived slight rather than being based upon an objective determination that the lawsuit is in your best economic interest. Do not let elevated testosterone levels get in the way of making a rational economic decision.  The  lawsuit is likely to continue long after your passions have faded.  By that time, you may be wrapped in the arms of that 800 pound gorilla.  If you have not made the decision to litigate based upon legitimate and dispassionate commercial considerations, you may find that your only way out is to settle on highly unfavorable terms.  This will not help you prosper.

A common mistake clients make is to assume that if a dispute is over only $10,000 to $50,000, the attorneys’ fees for pursuing or defending the case will be proportionately less than if the lawsuit involved $100,000 to $1,000,000.  This is not necessarily so.  The amount of time it takes to prove your case has very little to do with the amount in dispute.  The facts and issues, and the response of your adversary, determine the amount of time involved.  Since commercial litigation is typically billed by the hour, more time means higher attorneys’ fees regardless of the amount in dispute.  This reality should be taken into consideration when deciding to file suit, and likewise when considering an offer of settlement.

Some protection may be provided by the documents if they provide for the successful party to recover attorneys’ fees and costs from the unsuccessful party. But note: (i) you had better be sure you will be the successful party, or you may end up paying your adversary’s attorneys’ fees as well as your own; and (ii) you should consider whether a judgment against this particular defendant is likely to be collected.  If the defendant is on the verge of bankruptcy, or otherwise insolvent, obtaining a judgment that includes all of your attorneys’ fees will do you little good.  You will have just spent more money that will  not be collectible.  As the saying goes: “When you find yourself in a hole – stop digging.”

Remember.  The commercial dispute forming the basis of your lawsuit is yours, not your attorney’s.  Your attorney’s business is to represent you as your skilled professional advocate. Attorneys are bound to zealously advocate for your success, but they can not guaranty success and collection.

Deciding to file a lawsuit in a commercial dispute should be like deciding to get a kidney transplant.  It should be a decision that is not entered into lightly, and should be made only if the benefits to be obtained are greater than the burdens the procedure will entail. If you decide on a new kidney and go under the knife, be prepared to see it through. If, after the procedure has begun and your kidney has been removed, you change you mind and decide against a transplant, your decision is a bit too late.  The time to make that decision was before you got on the operating table.

I am not saying you should never file a lawsuit.  Each circumstance merits its own evaluation. What I am saying is that the time to decide is before the suit is filed.  Once filed, be prepared to do what must be done to win.  It is too late to un-spin the wheel.

                                                                                    Thanks for listening,

                                                                                                 Kymn

 

 

 

Questions abound about where our commercial real estate market is headed. As many suspect, where we were prior to the Great Recession is not where we are now, and not where we’re headed as we move forward. Things have changed. We have entered an era where the so-called “Third Space” will dominate commercial real estate development.

What is the “third space“? Urban planners describe it generally as the space designed for creative social interaction, which lies, figuratively, between home and the workplace.

From a purely economic standpoint, it is difficult to see how brick and mortar retailers in today’s marketplace can effectively compete with internet retailers not burdened with comparable fixed costs. Internet retailers have a huge advantage when it comes to convenience, accessibility, and price-competitiveness as compared to fixed location, brick and mortar retailers. Unlike the pre-2008 marketplace, today’s shoppers enjoy virtually limitless access to online goods and services. Online shopping is easy and convenient.

To remind ourselves, the commercial real estate industry began its skid in the summer of 2008, after the collapse of the sub-prime residential lending market in the Spring of 2007. The commercial real estate market experienced a virtual death knell following the collapse of Lehman Brothers on September 15, 2008.

With this backdrop, and the ubiquity of iPhones and other smartphones in society today, we sometimes forget that the very first iPhone was not even released to the public until June 29, 2007.  The first Android smartphone was not introduced until October 2008.  Twitter and text messaging were in their mere infancy in 2008 as the commercial real estate market crash occurred. Today they are the leading means by which the discretionary income-rich millennial generation (those born between about 1980 and 2000) socialize and communicate.

Yes, technology and our retail culture have changed dramatically while the commercial real estate market has been on hiatus over the past several years. What does that mean to commercial real estate investors and developers?  It means our developments have to change too.

The leading takeaway from ICSC RECON 2013 is the need for commercial real estate developers, retailers, lenders and urban planners to grasp the immense changes to our culture borne by the lightning-speed proliferation of social networking and technology.  Commercial  real estate developments, whether new or retooled, will need to create a reason for consumers to come to our commercial projects to shop and spend. To be successful, our projects will need to be fully integrated, media rich environments providing prospective customers with a compelling reason to come to live, work and play. They will need to provide an enticing third space between home and work for consumers to spend their time and money.

The current push in Congress to mandate collection and remittance of sales taxes on internet-based out-of-state sales may help state and local governments fill their coffers, but imposing this tax will likely do little to help brick and mortar retailers.The fact that online sales may be taxed to the same extent as brick and mortar based sales is not likely to dissuade online shopping.

Rather than begrudge the impact of internet-based shopping on brick and mortar retail, developers and retailers alike will need to wholeheartedly embrace technology to create an enticing, in-person experience that integrates online social networks with face-to-face social interaction and shopping. This is the challenge of our time for retail and commercial real estate development.

Meeting this challenge will require, first, that we grasp it, and, second, that we envision how to effectively integrate fundamental real estate development concepts with new and emerging technologies. To get to the desired bottom line, we will almost certainly need to understand and focus on the third space.

Thanks for listening,

Kymn

May 20, 2013. ICSC RECON UPDATE. Today was an exhausting but productive day. My Fitbit recorded nearly 20,000 steps, or roughly 8.75 miles covered. My feet hurt, so I believe it.

It was great to see friendly, familiar faces, from past and present – happy to be making deals again.  There is, for the first time in a very long time, an upbeat mood in the CRE industry, and an abundance of new construction and redevelopment projects underway.

I was interested to hear what community development directors from communities around the country had to say. To a large extent they are “open for business”, fully expecting to hear from developers seeking development incentives, and prepared to be of assistance.

Interestingly, some communities question whether development incentives should be necessary with development coming back. . . To which I have to respond: Really?

My reminder to communities is that

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May 19, 2013. Walking the ICSC RECON 2013 Marketplace floor, I am struck by the relatively few WOW exhibits of innovative products and solutions I find myself interested in. What do I mean by a WOW exhibit? Simply put, it is a product or service solution in a convention floor booth that when I see it I think to myself “WOW” that’s special.

I recognize this may be a function of who I am, the projects I am working on, and what I personally find interesting but, just the same, I am a bit disappointed. This is not to discount the functional value of products like trash receptacles, park benches, valuation services, drainage components, maintenance systems, and the like – I just did not find most of them particularly compelling or interesting.

Be that as it may, there were a few exhibits I was drawn to and did find interesting. These exhibits had varying degrees of WOW-ness, but they did make this day at RECON 2013 enjoyable. I will share my favorites here:

FIRST PRIZE goes to Liquid Fireworks by Waltzing Waters, Inc. of Cape Coral, Florida.

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May 14, 2013:  The Chicago Real Estate Council hosted a panel of experts during a lunch meeting today to discuss the current state of commercial real estate industry capital markets.  The panel was moderated by Dave Hendrickson of Jones Lang LaSalle, and featured panelists Steve Kay, from Cantor Fitzgerald representing CMBS markets, Matt Napoli of PPM America, Inc. representing the life insurance company perspective, Mark Witt of Pearlmark Real Estate Partners, an equity funded mezzanine lender, and Dave Patchin SVP of Fifth Third Bank.

The panelists discussed the tremendous uptick in commercial real estate lending over the past year in all product types, and the prospects for dramatic growth 2013 and beyond. Interest rates in the 3% to 4% range are prevalent with loan to value ratios of 60% to 75% typical.  The spread on LIBOR based loans is typically around 200 basis points above LIBOR.

All primary loan panelists agreed that they prefer to finance projects without the use of mezzanine financing, but in certain circumstances they will consider permitting mezzanine financing.

The consensus was that interest rates are likely to remain flat for the next 12 to 18 months, but that over the next five years interest rates are likely to rise roughly 200 basis points.

None of the panelists expressed concern about the Chicago market overheating in the foreseeable future, but they are being more diligent in evaluating multifamily development and acquisition loans due to rising concerns about absorption of all the recently announced new apartment developments in the City of Chicago.  Generally, however, the sense is that multifamily projects in desirable downtown locations remain attractive, while projects in fringe locations pose rising risks.

Nationally, some markets show signs of overheating – with cap rates and purchase prices skewed. This is likely a consequence of historically low interest rates permitting increased cash on cash rates of return.  The concern is, once again, the potential loss of value when these loans must be refinanced in 3 to 7 years if interest rates have risen significantly.

A general consensus was expressed that the Chicago commercial real estate market continues to have strong growth potential into the foreseeable future, and that secondary and tertiary markets also represent significant areas of opportunity for CRE investment.

Bottom Feeders – and Bottom Feeder Funds – Our New BFF?

Bottom feeders have a distasteful reputation with some – but, truth be told, they are among the most reliable leading economic indicators of recovery for the commercial real estate industry.

There is a stunning disconnect between equity markets and the economy as a whole. The Dow Jones Industrial Average is at record highs, with 15,000 in plain sight.  Equity investors are betting on a bright future. To gauge the economy by that measure, the economy appears to be healthy and rebounding nicely.

Leave Wall Street, and drive through urban and suburban retail districts, and the picture is not so bright. Vacant and boarded up storefronts are common. Parking lots are in disrepair. Shopping center signs are blank – or filled with half burnt-out signs displaying names of tenants past.

Sure. Commercial deal flow is beginning to pick up, but compared to what? A car travelling three miles per hour can triple its speed, but it is still moving at a remarkably slow pace by most standards.

I went for a drive recently, touring retail shopping centers and office parks to find out where the action is.  The answer?  Almost nowhere.   It didn’t really surprise me. Although deal flow is picking up in my practice, most deals are with cash-rich bottom feeders (or bottom feeder funds)  buying up distressed properties.  Not that I’m knocking bottom feeders. Chances are good they will (more…)