Few commercial buildings are being sold in the Portland-metro market. While many commercial real estate brokers are being questioned about great opportunities, it is difficult to find these opportunities and, more specifically, a purchaser willing to execute a transaction. With that said, many real estate professionals believe now is the time for owners-users/investors to take advantage of historic opportunities.

The overall market is stabilizing. Local businesses that operate in the national market are reporting that business is picking up in other areas. Markets like Phoenix and Denver are reporting leasing activity not seen in several years. Portland-area brokers in different disciplines and submarkets speak of tightening. There will be significant pressure by the federal government to improve the business climate before the November election. Local banks are discounting values of residential subdivisions, and selling to optimistic home developers planning to commence construction.

From a real estate perspective, current building owners have suffered through this business climate for two years. While they would prefer to retain their buildings, the financial health of their businesses and their personal financial security are more important. Many have equity tied up in their properties, which they would like to access.

From an investor’s perspective, consider:

• No new product is being built on a speculative basis.
• Many suspect that inflation is coming, due to the current federal monetary policy.
• Capitalization returns are at least 150 to 300 points greater than three years ago.

So, is financing available? Today, cash is king. Sellers need cash, and buyers with cash are in stronger positions. Pressure is being applied to banks to lend to small businesses, and insurance companies have cash they would like to lend in real estate.

Other alternatives exist. Small Business Administration loans are available to owners/investors who will be occupying 51 percent of the building. Interestingly, because of the structure of these deals, they seem to be less impacted by appraisals. Additionally, credit unions and private equity funds are lending money. Seller leasebacks, whether a master lease or partial leaseback, can improve underwriting prospects. These leasebacks can be secured by placing a second mortgage on the property as a guarantee.

It is important that buyers, much like home buyers, line up their source of funding in advance and understand the underwriting requirements. The ability to make a clean offer showing the seller a clear solution is very helpful. Environmental companies, contractors and engineering businesses are slow. This enables the buyer to shorten the contingency period. While many sellers may not be ecstatic about the proposed purchase prices, if they are assured that their economic situation will be improved, they are more willing to make necessary concessions needed for an agreement.

So, how do investors structure a deal?

• Make sure the prospective investment rental rates are realistic. There can be no inflated value based upon rental rates of even two years ago. Also, make conservative allowances for lease-up expenses.
• Buy below replacement cost. Buyers must know both current land and construction costs.
• Think positive leverage. The capitalized rate of return should be above the mortgage interest rate.
• Think positive cash flow. A portion of many investments require leasing up vacancy. During the lease-up period, be confident of positive cash flow.
• Qualify the lender. Understand the lender’s underwriting requirements and make sure the lender’s representative has the authority, or at lease can speak authoritatively, about the lender’s requirements.
• When structuring a pro forma, recognize that when a property has 25 percent to 30 percent vacancy, its investment value may not benefit the seller. Transactions have been closed in the last year where the investor made an allowance for one-half to two-thirds of the vacancy with an additional price reduction or holdback for specific lease-up expenses during the first 18 to 24 months. These expenses should include, but are not limited to, lost income, real estate fees, rental concessions, tenant improvements, deferred maintenance, management, accounting and legal fees. While these holdback expenses should be determined prudently, the impact of this structure does not lower the price as much as strict capitalizations of vacancy, and may allow an investor to pursue an opportunity, without undue risk.

Investors shouldn’t freeze up over trying to achieve the absolute lowest price. The general consensus is that we are at the bottom or at least bouncing along it. It is likely that in five years, buyers will be thrilled with any current purchase. Remember that any price or return is going to be significantly better than what would have been achieved three years ago. A return of 8 percent to 10 percent on real estate is a good alternative to the vagaries of the stock market. Depreciation, appreciation and the tax benefits of interest and write-offs of building expenses are still very attractive benefits of owning real estate.

While business news is still uneven, and many are concerned over the passing of Measures 66 and 67, the vast majority of Oregonians will continue to live and work in Oregon. And Oregon’s financial challenges are not just limited to this state – many states are insolvent and looking to individuals and small businesses for the rescue. Remarkably, it has been reported that Oregon’s corporate tax system is one of the most advantageous (top third) in the country. Individuals from other states continue to move to Oregon, and Portland’s Urban Growth Boundary will continue to protect the value of existing buildings.

This may not be the time to be speculative, but a proactive, creative approach is appropriate. Now is the time to take a hard look at investing in commercial property. To paraphrase the film classic “Major League,” “This may be the at-bat we’ve waited our whole life for.”

Steve Dodds is a vice president at NAI Norris, Beggs & Simpson, a real-estate brokerage and asset/property management company. He specializes in industrial leasing and sales. Contact him at 503-223-7181 or sdodds@nbsrealtors.com.

The post Why to buy now: opportunities in the commercial real estate market appeared first on Daily Journal of Commerce.

In the last 10 to 15 years, Portland has seen a metamorphosis in its traditionally industrial neighborhoods, as redevelopment of structurally or functionally obsolete buildings into multi-tenant, multi-use facilities became an attractive opportunity for entrepreneurs. Even recently, many of those obsolete buildings were purchased and demolished to make way for condominium projects and coffee shops.

But as history predicts, the pendulum seems to be swinging back toward commercial redevelopment, and new opportunities for industrial redevelopment are emerging. 

The previous redevelopment model for core industrial buildings was simple. Developers sought multi-story buildings with vacant floors or single-story buildings with non-functional floor plans and architecturally inconsistent additions; buildings with existing windows or windows that had been filled in or covered with metal; or buildings with multiple entrances on different streets.

These properties were often located in what was then Portland’s newly created “EX” zone, which allowed mixed-use development, or in “IG1” or “IG2” general industrial zones near EX zones.

Redevelopers could buy properties for $30 to $60 per square foot and invest like amounts, bringing their total investments to $70 to $100 per square foot. After allowances for redevelopment costs, the properties could be leased for 55 cents to 80 cents per square foot, triple net, per month. The capitalized investment values of the properties were often 20 percent to 30 percent more than the total project costs. Redevelopers were creating value while creating a profit.

Just as important to this model were the users who leased the spaces. They included small manufacturers, importers and exporters, ad agencies, Web designers, carpenters, manufacturer representatives, caterers, local retailers and home design suppliers that flocked to these types of facilities. These users fueled the evolution of the Northwest Portland Industrial District and then spread to inner Southeast Portland, the Hawthorne District and North Mississippi Avenue. 

Redevelopments of industrial properties – like the former Beaver Sales building in Southeast Portland, the General Tool & Supply building in the Pearl District and the former Northwest Marine facility in the Guild’s Lake Industrial Sanctuary – proved this type of redevelopment could be successful. A recent large-scale example is Cathedral Park Place in St. Johns, a 280,000-square-foot single-tenant building that now has over 60 different lessees.

But in the last several years, Portland’s condo boom pushed the price of EX-zoned buildings from as low as $50 per square foot to as much as $250 per square foot. Additional factors – such as low interest rates, easy underwriting for condo projects, and investments fueled by 1031 exchanges – helped fueled this explosion in value. Buildings that would have once been excellent candidates for redevelopment were instead purchased and torn down. Many redevelopers that had been buying one or two buildings a year to redevelop found themselves priced out of the market. Not only could they not create any investment value from the purchase of these properties at their new market values, they couldn’t capitalize rent at the necessary rate. Redevelopers found themselves pushed to the sidelines. 

Some well-located buildings, like the Jasco Block at 2001 N.W. 19th Ave., were still redeveloped. But because the purchase values of such properties were so high, rental rates around $20 per square foot, triple net, were demanded – rates similar to those of the central business district and far out of reach for the previous tenants of redeveloped properties.

But things change. Portland’s oversupply of condos and the declining demand have reversed the land price surge in the EX, IG1 and IG2 zones. Although some apartment developers are still pursuing opportunities, their pro forma for land is one-third to one-half of what it was only six or eight months ago. Additionally, tighter underwriting requirements have left many building owners, who didn’t sell their properties within the last year, facing a different market than they’d anticipated. 

The market for these buildings with redevelopment potential is in a period of transition. 

Although the rental rates for small industrial spaces have continued to increase over the last several years, they don’t justify the market value that many owners had projected for their buildings six months ago. Like it did when the dot-com bubble popped, speculative value has come out of the market. A return to sound investment criteria has redevelopers anticipating the ability to again create “development value.” As with most periods of economic transition, opportunity for profitable redevelopment should follow.

Steve Dodds is an industrial broker and associate vice president with NAI Norris, Beggs & Simpson in Portland. Contact him at 503-223-7181 or sdodds@nbsrealtors.com.

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