More and More…and More

This project has been in the works for a long while so it’s timing on coming to market with so much other product is just the luck of the draw.

It’s not clear what their original purchase price was for the old Cannon Equipment site but given the requisite brownfield cleanup I would suspect it was good. That should allow them to weather the current saturated market.

It’s worth revisiting the estimate noted at the ULI conference last fall that “it could easily take five years to reach anything close to full lease-up.” That means every other project that comes to market extends that time frame. Short of an unprecedented demographic influx of renters to downtown there’s going to be room to grow for a while.

If there is a silver lining here it’s that anyone coming into the market will need to provide a better price point or more unique product because more of the same isn’t going to cut it. So, hopefully, in a couple years maybe we will see some really interesting and creative residential solutions.

Cultural Differences – Know Who is Across the Table

Reading that there are nearly two dozen German companies in the area ( reminded me that there are cultural differences in the way people from different countries approach real estate. While we have a very strong system set up to support real estate ownership and transactions it’s not the same around the world and when engaging with other cultures it can be critical to understand the idiosyncrasies they have in order to be successful.

For instance the majority of Germans do not own their own homes. They are one of the largest leasing oriented countries with something like 80% or more not being owners. This will have obvious effects that we can see but also not so obvious ones like the limited number of potential buyers and a system that is not as efficient in transactions.

Another example are Middle Eastern countries. Their system of laws around real estate and their understanding of contracts is vastly different than ours. Where we have a simple underlying belief that if I sign a contract with you today we are in a ‘Contractual Relationship’ and we will follow its course to the end many Middle Eastern countries do not have the same adherence or even basic belief in such rigid structure. You can sign a contract today and find yourself tomorrow completely renegotiating it or worse find that there is a second contract they have entered into. They see nothing wrong with this and consider that if you wanted the property you would have bought it, without consideration for any due diligence. There is also a distinct bartering mentality which will drive you insane if you’re not prepared for it. Middle Eastern cultures will retrade and renegotiate endlessly – even at the closing table – in order to get even just one more dollar. This is not viewed as wrong or disrespectful but actually as good business. As fighting for every last possible bit of value. It’s just much more fluid than we’re used to.

On the opposite end of the spectrum would be Asian societies where structure and a rigid adherence to a way of doing business can seem almost stifling and if you don’t do your homework you can lose a deal before you even have it presented.

In short, as with all deals do your homework on who the other party is, their style and motivations. You don’t want to lose out on a deal because you decided not to join the Japanese for Sake and karaoke after a long day of negotiations. Sake and karaoke is not optional.

What’s It Worth – Let’s Talk Valuation

So you’re looking at a building and trying to figure out what it’s worth. How do you sort out a value?

Well, that depends (everyone loves that answer I know). It depends on where you are standing naturally. Are you the owner? Are you a lender? Are you an insurance company? Are you a buyer? Each of these (and many others) will come up with a different valuation of a property based on their unique perspective.

An extreme example of the variability of valuation occurs when we look specifically at appraisals. Whomever orders the appraisal will dictate the bend of that valuation. When a bank or lender orders one it will be different that when a buyer or seller orders one directly. This can be extremely confusing as we like to think that there is just one price for something. However, appraisals can vary substantially based upon their purpose and it’s not generally viewed as manipulation.

Value changes based upon where you are looking at a property from.

Let’s put the esoteric discussion on hold for a bit and discuss the basic fundamentals of valuation and then we can come back to how they are ‘nudged’ depending upon who is directing the valuation.

In appraisals there are three standard methods for determining value: Income Approach; Cost Approach; and Sales Comparison.

In general appraisers will use two of the three methods to ‘derive’ a valuation for the property. Typically the Cost Approach valuation is the one that is dropped as it is furthest from what is considered a ‘market value’.

Income Approach:

At its most basic the Income Approach is determined by subtracting the expenses from the income.

So the math looks like this: Income – Expenses = Cash Flow

Pretty simple but now we need a way to easily compare it to another property. We need Net Operating Income or NOI which is the income that is left after subtracting vacancies, losses and expenses. The NOI can then be used to calculate what is called the Capitalization Rate (cap rate) or the estimated rate of return from the property assuming you bought it without leverage (loan).

So, the math looks like:

Income – Credit Losses & Vacancies – Expenses = Net Operating Income (NOI)

NOI / Sales Price = Capitalization Rate (Cap Rate)

So, if you have $100,000 in income; $30,000 in Credit Losses, Vacancies, Expenses and a sales price of $1,000,000 your Cap Rate is 7%.

$100,000 – $30,000 = $70,000 (NOI)

$70,000 / $1,000,000 = 7% cap rate

Cost Approach

The most straightforward and often disregarded method of valuation in commercial is the Cost Approach method. This is simply what would it cost, in today’s dollars, to acquire the land and build the same building you are looking at. In most markets market pricing is well above replacement, however, it is always good to be aware of and consider. If you can buy land and build exactly the same building next door to the one you are looking at for less its value is undercut.

Sales Comparison:

Most people who have bought and sold a residential property have seen the Sales Comparison (comp) method as it is the primary technique utilized by residential appraisers. There are many more houses than there are commercial properties so the Sales Comparison method will usually provide a good indicator of where the market is. When dealing with commercial sales it can become much trickier since there are not as many similar properties to compare.

In using Sales Comparison the goal is to find like properties sold within the prior two years to provide a guide in valuing. For instance if you are trying to value a 50,000sf shopping center you may have to look at a wider geographical area to find something to compare to and you may actually have to look at different sized properties and then compare on a per square foot basis in order to get to a valuation.

In finding similar sales you will again need a good way to translate the value of the sold comparable property back to your target shopping center. Traditionally a Price Per Square Foot is used as it helps to deal with variation in property sizes. So, if you look up the recent sales and find a 40,000sf shopping center nearby that sold for $5,400,000 you can quickly determine that it sold for $135 per square foot (psf) and use that to estimate your valuation.

$5,400,000 / 40,000sf = $135psf

Difficulties can arise if the property you are trying to compare is in a town of say 100,000 people and there are only a handful of similar centers. It may be necessary to expand the scope and include any strip retail in order to actually find a comparable. Though a dialed in broker will have a good sense of where the market is for a particular product type it’s hard to build a serious valuation on a brokers ‘feel’ for a product.

You can quickly see that with a limited pool of comparable sales to use it can be quite difficult to come up with a strong valuation consensus using the Comparable Sales method alone. Which is why it is typically used in tandem with the Cash Flow method to help inform the valuation and not as a stand alone.

Now you understand the fundamentals so let’s get into the interesting stuff! First you need to know that there are two written and formal ways of setting a market valuation for a property: first is the Broker’s Opinion of Value. This is the less used, quicker, easier and less accurate form of gauging the market value of a property. Each state is different in how they outline the process for a broker to provide a valuation so it’s not worth getting into the specifics but suffice to say these are typically based upon a market survey of similar properties and current sales. Essentially a listing and sales comparable approach. Many brokers will not provide these as it can be a significant liability if the person they provide it do disagrees with their assessment.

Second is the more traditional appraisal completed by a professional appraiser whose only job is the valuation of properties and who is bonded and insured to provide valuations. Appraisers are the default arbiters of value and are relied upon in the market for valuations.

A bit About Appraisers:

As I said in the beginning valuations will vary depending upon who is ordering the appraisal. This can be most obvious in residential. Following the downturn in 2008 the residential appraisal industry took a lot of heat and the way appraisals were carried out changed dramatically. Before the change appraisers were local and went to each house they appraised rendering their value and being very well informed of the local valuations. Following the change they were able to do appraisals remotely and the person doing your appraisal now may never set foot in your town. It’s all data. This change was in large part to shield appraisers from influence. Prior to the change it was not unheard of to have brokers; bankers and even property owners ‘helping’ appraisers to get to a specific number that was needed to close a deal.

Thankfully in commercial this kind of nonsense is far less likely. Mostly because the commercial appraisal takes much much longer, costs more and in most cities there may only be two or three people qualified to perform commercial appraisals. Typically commercial appraisers have a substantial and rigorous training period in residential before they’re even allowed to look at a commercial property. Commercial appraisals can take months to complete and are huge. Some can run to more than 100 pages. Residential appraisals take less than a day.

We can just say that in commercial there are a lot more zeros involved and this makes it much more complex and less susceptible to funny business.

Where it Gets Muddy:

Who is ordering the appraisal and what’s the purpose? These are the questions you will be asked when you call up and order one. If it’s for a purchase and is being ordered by the lender they will want it to be very close to the contract price. If it’s not – and in commercial this does happen – then the buyer likely will have to come up with additional capital to cover the difference as the lender will follow the appraisal.

However, if the owner of a building orders an appraisal because they want to know what their building is worth you can bet it will be different than if there was a contract. That is not to say that there is anything wrong with the process. It’s called anchoring and without an anchor that is provided the appraiser will use only the market indicators to derive the value.

If you are a buyer and you order an appraisal for yourself it will be different – lower – than if the seller ordered the same appraisal on the same building. Perspective makes a difference.

Again – and to stress – there is nothing nefarious here. These are the vagaries of valuation. How much something is worth depends a lot upon who is valuing it. We could go down the economics rabbit hole here but let’s not because I can see a lot of you dozing off already.

And So:

You need to be aware when reviewing an appraisal where it came from and under what circumstances it was ordered. There is a day coming when appraisals will be fully automated, it really is all just data, but until then we need to be able to understand the nuance of how value is derived.

New Condo Building Downtown

The integration of automated parking into projects is making its way to downtown and with it some new condos that I suspect will find a market ready for them. Given the recent taste for building for lease multifamily rather than condos I would bet there is some latent demand for condos downtown. This will be an interesting project to watch both for the sales but also for the developers willingness to shoehorn residential into buildings where most cannot imagine it. This is how innovation happens.

Apartments to Hotels – How to Pivot

Quick thinking developers and building owners seeing the glut of rooms on the apartment rental market have begun to pivot to hotels. A wise move and one that can be quite lucrative. Though now we have the concern about having too many hotel rooms but hey it’s always something isn’t it.

Keep an eye on these projects and see how downtown absorbs and builds around them. Those that get left on islands where there is little else will have a hard time in the long run.

And the Cycle Continues – Multifamily DOWNtown

John Wise says it well: “…I’m afraid the party is over and there are going to be some tough times for some developers.”

In every real estate cycle there is the BOTTOM, the UP, the TOP and the DOWN. Calling the BOTTOM and TOP is hard to do but seeing the UP and DOWN is much easier. We are now seeing the long called for DOWN with discounts, desperate marketing efforts and other tricks starting to come out. In time we may see the next phase of a down: sales. Discount sales as lenders and investors pull the plug on projects they’re just going to write off as a loss. Those are usually a good indication that the BOTTOM is close by.

How long any of this actually takes to happen is a guess and is dependent on lenders staying power and devotion to the market. A local lender / investor with long ties to the market may stay with a project and work with the developer / owner to restructure the debt or delay payments in order to weather the downturn. Most national lenders and equity players have a much shorter fuse and when things look like they’re going to take a while to rebound many will cut bait. Take their lumps and move on.

This can be a great deal for tenants with lowered rents and all manner of incentives. It can also be great for those looking for an opportunity to buy into the market as some of the projects may trade at a discount. With a new lower basis it will be easier to ride out the market downturn and then make even better money in the following UP cycle.

Online Security Issues in Commercial Real Estate

A topic that may not get addressed enough in our headlong rush for the next deal is security. Especially when we consider the online portion of our business. We can all be forgiven for being neck deep in a deal and missing a few points in a long contract before execution. Pressure gives us a narrow focus and we tend to miss things, however, the potential downside when dealing with anything online is growing exponentially and is worth the time to pay a little more attention to.

Watching the ransoming of the entire city of Baltimore going on right now should be a pretty serious slap to anyone who doesn’t think really nasty things can happen to them.

If you are online you can be hit. We like to imagine that we are small potatoes compared to all these corporations and cities being hit and no one would bother targeting us. And you’d be right, except for the fact that it’s not individual hackers focusing on individual businesses it’s computer algorithms. Bits of computer code that don’t get bored or tired but are constantly crawling all over the internet scouring for any weakness. No they’re not ‘looking for you’ exactly but they are looking for your open backdoor.

Commercial real estate is an attractive target for hacking because we deal in large amounts of capital moving around on a daily basis. it’s not unusual for a brokerage office to see more than $1,000,000 in money transit its systems in a day. Earnest money deposits, commission fees, leasing deposits, etc. These can be very attractive to someone hacking and looking for cash.

Title companies as well are big money targets and in fact have already seen a huge number of attacks on them in the last few years. If you’ve wired money for a deal in the last few years you’ve already seen the additional verification steps title companies go through now.

One of the most effective and lucrative methods hackers have been using to target the commercial real estate industry are those using email. We have all become pretty good about not clicking on random links emailed from unknown senders but what about the link your friend Dan just sent…

Hackers are getting very good at ‘spoofing’ or faking the source of emails. If they can watch your email traffic for a while and see that you communicate with someone they can spoof that address in the From field to fool you into thinking Dan really did send you a link.

This recent article in BisNow details a bit more of the mechanics that can be used in a hacking attack:

It can sound a bit like you’re in another Oceans Eleven film but it’s actually happening now more frequently because of automation. The tools available and the techniques for attacks have advanced so far that you don’t need to be a serious hacker or spy to carry out complex targeting.

Do yourself and your business a favor and spend some time getting familiar with the latest hacks. It’s hard to be vigilant against an attack if you don’t know what you’re looking for.

Market Drivers

One of the hardest things to really get comfortable with as a commercial real estate (CRE) investor are the drivers of the particular market you are in. What I mean by drivers are the things that directly affect the particular genre of CRE you either own or are interested in.

For instance if you own a 20,000sf warehouse the Market Drivers you are looking to understand are those things that will impact your ability to lease your space for the highest possible price. Including: whether the city you’re in is attracting and growing businesses that need warehouse space; whether others are building additional properties on speculation and thus affecting the supply of similar spaces; whether there has been a legislative change that will somehow constrain or limit potential users of your building. These are your Market Drivers.

Market Drivers are what should keep you reading the news everyday and doing your best to keep up with the shifting of the local business climate.

Chattanooga has been a transit hub for a long time. It’s well positioned roughly a two hour drive from so many population centers it has a distinct geographical advantage. This was not lost on people in the business of transportation and there have been many companies founded and moved here for exactly that reason.

The news today that Arrive Logistics has raised another $25m for future expansion is a prime example of local Market Driver. Their expansion will naturally require an expanded footprint in proximity to their existing headquarters.

With the volume of office space available in downtown and the growth of downtown residential this is a very important step in filling out the core of Chattanooga and making it a 24hr city.

Congratulations to Arrive Logistics and especially to downtown Chattanooga this is a great step in the right direction.

Top Ten Seller Mistakes

To be fair to buyers there are plenty of mistakes sellers make. Some are similar and some are unique and well worth paying attention to. Again this is my list of ten from my experience in no particular order. Each of these should be understood and avoided.

  1. Are you selling or fishing
  2. Where are you going to put the money
  3. FSBO
  4. Knowing where the market is
  5. Failing to assemble a full package on the property
  6. Not having a lawyer
  7. Understanding the timing
  8. Not Cleaning Up Title Issues
  9. Fixating on price
  10. Underestimating the costs of selling

Are You Selling or Fishing:

Why. Why are you selling. What is your goal. What is your motivation. If it’s not clear to you you’re going to be pulled all different directions in the process and have a very hard time getting the deal to close.

‘Fishing’ is saying “I’d sell if the price is right”. That’s not selling. Everyone who owns a building will “sell if the price is right”, listed for sale or not. Fishing is saying “I will only sell if I get my price”. This is hubris. You’re saying to the market that you know best.

There is a stigma that happens to properties that have been listed for sale for a long time. First and foremost people think there is something wrong with the property and second seasoned investors and brokers can smell that the seller isn’t ready to sell. They’re fishing.

The best indicator of this type of hubris (that I had never seen until moving to Tennessee) was a seller INCREASING a listed price with no explanation of added value. If you take a vacant building and get it leased up there is value there to a buyer. If you just wake up one day and say I think the market has gone up and I’m going to raise my price you’re not a seller.

Get clear on your motivations and goals before you come to market. Fishing wastes everyone’s time.

Where Are You Going to Put The Money:

Sometimes individual sellers don’t consider their next steps prior to putting their properties on the market. More often than not though it is a partnership that decides to list a property for sale but fails to let everyone know or deliberately doesn’t. Regardless of the cause if you are caught at closing and you have not set up an exchange you will be liable for the taxes. A brutal lesson in considering the future.

Keep in mind I am not saying run out and spend the money on a boat or some other bit of nonsense. I’m saying you need to plan your exit as well as you planned your entrance, if not better. To pay the tax can reduce your gains to the point that your investment return is as bad as having left the money in a savings account. You don’t want this.

So, understand the exchange process. The requirements and the steps. Learn it well before you need it. Selling is very stressful and exchanges can be doubly so. You are doing two transactions.

It goes without saying that you should have a good CPA and they should be up to speed on your plans. If they understand your desire to sell they can help you structure everything. They may even know someone looking for a property like yours.


This is pretty simple: do not sell your own property. Don’t do it. In the residential world it’s not a big deal to sell your own house or that short term rental that didn’t work out quite so well but commercial is a whole different animal. Unless your job is selling the type of property you are listing don’t do it.

Harsh? Yup. FSBO in the commercial world kills more deals than just about anything else. The fee you pay to a good listing broker to handle all the details of the sale is well worth it. Most importantly you want their expertise in determining pricing, targeting potential buyers and keeping track of interested parties. You will get a higher price with a broker than without. Don’t think for a moment you’re saving any money. There are plenty of buyers that will not even look at a property listed FSBO because they’re so difficult to deal with.

Keep it simple and say NO to FSBO.

Knowing where the market is:

I realize that I just told you to hire a broker to help with selling and now I’m telling you to know where the market is but they’re not in opposition. Wherever you get your information you need to understand where the current market for your property is. Without understanding this you will have no idea how to plan for the timing, contingencies or other issues that may be specific to the current market.

An extreme example was the downturn in 2008. Actually late 2007 when very suddenly, around September, the CMBS market dried up. If you had gone to list your 20,000sf mixed use property in November and not been aware of where the lending market was you’d have been in for a rude shock. Not that the downturn wasn’t rude enough on it’s own.

Knowing the market, even in a cursory way, will also help you understand where your property fits in the market. Are you the nicest house on the worst block, so to speak. What are the strengths of your property and the weaknesses. Where can you expect a savvy buyer to zero in on their due diligence and use to try and get some concessions.

So as you begin to consider selling have conversations with your CPA, your lawyer, your banker and maybe especially your broker. To understand the current market and what issues may arise that will impact your potential sale.

Failing to Assemble a Full Package on The Property:

Well if you hire a broker they’ve put together a full package, right? Well, yes they should do that but it is reliant upon you as the seller getting them all the relevant information to build the package. Just saying ‘list my property for $1m’ is going to make life a pretty big pain for everyone.

Collect and deliver to your broker income and expense reports; rent roll; capital improvement details for the prior two years; tax records; legal / dispute records; insurance claims; etc. The more detail you can provide the better package can be built and the better picture a buyer can get even before they walk your property. Every property has issues. Don’t hid yours put them out there right next to the good stuff so buyers can determine whether they can make it work.

When you don’t provide a complete package up front you are setting up for seemingly endless requests by potential buyers for everything. Clean it up and make it faster for people to evaluate and get to yes.

Not Having a Lawyer:

I said it before in the buyers mistakes post and I will say it again louder here: GET A REAL ESTATE LAWYER.

If they don’t know what ‘estoppel’ is they’re not a real estate lawyer. Get someone who knows the local market and understands the type of building you are selling.

In many states the seller has very little to do and in fact has very few options to exit a contract once it has been executed. Having a lawyer on your side can help mitigate this and a myriad of other potential pitfalls.

Understanding The Timing:

As a seller you need to have a good understanding of how long things are going to take. You need to be able to set not only your (and any partners) expectations but you will need to be able to anticipate when certain things might occur.

A great example is knowing that the 1500 acre ranch you just listed for sale could take between two and five years – or more – to sell. If you understand this you will plan accordingly for next steps and determine your required due diligence period as well.

How long do you need to wrap up any projects with the building? How long do you need to secure an exchange property? How long do your partners require? How long do you need to move all that stuff you’ve been storing out behind the building?

Get a clear understanding of how long you expect the listing period to take; the due diligence period and any contingencies as they come up. If the buyer is going to require a Phase II Environmental Report to be completed how long is that going to take.

Not Cleaning Up Title Issues:

Many, many properties have title issues that need attention. From legacy easements to rights of way. As a seller you should pull title to your own property and review everything in it. if there are issues you need to work to get them resolved before listing.

Title issues can sink deals and fast. If the property has an abandoned utility easement and you do not get it formally vacated your buyer will likely require it prior to closing. This can delay or derail closing.

Have a title attorney assist you if the issues are at all complex. Again, your brother’s friend who is a lawyer is not the guy you need. You need someone who specializes in title work.

Fixating on Price:

Look we all want the highest price possible when selling but price is typically not the sole consideration. There are timing concerns; accomodation of an exchange; deferred maintenance to be finished; titlework to be cleaned; etc.

As a general rule you can have price OR terms. If you get your price it’ll be the buyers terms and vice versa. It’s never that clean though and there are always things where negotiation and compromise is required.

I have seen sellers kill deals over $50,000 on a $2,000,000 deal. Is there another buyer out there, possibly, but why would you kill the deal you have.

Underestimating The Costs of Selling:

Selling is expensive. Broker fees; transfer fees; title fees; closing fees; etc. A good rule of thumb is to figure ten percent of your deal will be fees (obviously this varies substantially, especially on big money deals). Still you need to be prepared for the expenses. Plus if you’ve not made plans to exchange your biggest fee will be the taxes on the gain.

It is wise to go over all of these early in the process with your broker and title company to ensure you are planning for them. For certain things there may be ways to save a few dollars but you cannot eliminate all of them. Plan ahead and avoid the surprise at closing when the proceeds you thought you were getting have a haircut.