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Maximizing commercial real estate value:
Manage your properties as though they’re always for sale
By Bob Sullivan, CCIM, NAI Sullivan Group
It’s a great time to be a seller of commercial real estate (CRE). The Oklahoma City market has experienced substantial growth over the past 10 years showing a marked decrease in the availability of commercial real estate for sale. Currently, there is great demand for every type of commercial real estate, retail, industrial, office, land, and any type of investment real estate. In addition, there’s an enormous amount of institutional capital that’s been earmarked for CRE. Finally, capitalization rates, the ratio of net operating income to capital cost, are by traditional standards in most markets relatively low, maximizes the sales price to the seller. Add to this the fact that the IRS permits 1031 exchanges – a means of swapping properties among multiple parties which greatly expands flexibility and can defer capital gains taxes and your basis into a new property – and conditions overall become extraordinary.
So what steps should would-be sellers be taking to maximize their property’s sales value? As it turns out – there are many. But the trouble is that if a seller is waiting until only now to take such steps, they’re probably too late.
The basics of valuation
The fact is, you can’t wait until it’s time to sell to address the drivers of property valuation. Instead, you need to proactively and systematically optimize individual property and overall portfolio value at all times.
Start with the basics. Location matters. So does overall architectural desirability and property condition. So the first step in ongoing property and portfolio optimization is to make sound decisions in areas such as initial acquisition and ongoing maintenance. Maintenance is particularly critical along with tenant relations, as you don’t want to create a reason for a valued tenant not to renew their lease.
Another means of optimizing valuation is to continuously evaluate how a property is being financed. We recommend constant communication with a sophisticated mortgage expert to conduct semiannual reviews of property financing. Even minor improvements to financing can significantly improve cash flow and value. But the one caveat here is to be aware of potential covenants, such as a pre-payment penalty, that might be triggered in a sale. If you’re proactively looking to sell, look carefully at financing terms – or hold off on refinancing. The market is currently undergoing a change in financing options including rates, fixed amount of years to lock in a rate, financing “points”, and amortization term. You need to have several financing options as you look to re position a property.
The most important thing to keep up with is market conditions. You need to keep up with competing leasing rates, tenant improvement allocations, current market vacancies and new construction that will affect leasing rates and vacancy rates.
Retain those tenants
Owners need to keep their buildings occupied. The loss of any tenant can lead to significant expenses including lost rental income, new tenant build-out allowances, brokerage commissions – to name just a few. In general, higher renewal rates translate into more secure cash flow and higher valuations. So one of the most important steps to optimizing the value of any CRE portfolio is to build and maintain a robust tenant retention program. Key components of such a program include:
Identify “most valuable” tenants.
Some tenants are just more valuable than others. It could be their sheer size in relation to the rest of the portfolio – their failure to renew represents too great a risk to cash flow and value. It could be that they are less cost sensitive than other potential renters or lessors – negotiating less hard to obtain the lowest all-in costs. Or theirs could be a marquee name, aiding in attraction and retention of other retail or office building tenants. Regardless of the reasoning, CRE managers need to understand the relative value of their tenants and to allocate retention efforts and resources accordingly.
Conduct ongoing relationship assessments.
Property managers should conduct ongoing assessments of the state of all, but especially their most valuable, tenant relationships. Ongoing communication with key tenants should be a given – and of course the more valuable the tenant, the more intimate the interaction. Address issues proactively, preventing small issues from growing into larger concerns that could lead to non-renewal. Even in cases of many smaller tenants, property managers can use tools such as customer surveys to get a sense of conditions and what might be done to improve satisfaction and boost renewal rates.
Be equally proactive in renewing leases and rental agreements. All too often, property managers wait until 180 or so days prior to the end of the contract term before seeking renewal. Instead, formal renewal efforts should begin at least 12 months if not 2 years for larger and/or most valuable tenants. The earlier the process begins, the more likely it is that the property manager can identify potential problems that can often be overcome in time to still secure a renewal.
Be especially watchful of property maintenance and attention to Tenant issues bring a quick response and a quick resolve.
Proactive, ongoing, disciplined
Indeed, it’s a seller’s market across most of the nation’s major CRE segments. To take full advantage of the market and investor demand for quality properties and achieve top valuations for your asset, it’s important to deploy an ongoing, proactive and disciplined approach. And the time to start is now.