A couple of weeks ago, I wrote about a system for analyzing an investment property, commercial lease, or potential building purchase.
I used the acronym FOCUS, and I deferred our conversation on the S, the solution step as it was column worthy all by itself. As you may recall, FOCUS stands for Facts, Opportunity, Consequence, Understanding and Solutions.
Solutions may splinter into several directions. However, they generally fall into one of three categories: do nothing, do something or defer a decision. Simply, if you’ve sold an income property, have used the FOCUS approach to determine your next move, and are to the solution step, you may choose to pay the gains (do nothing), purchase another asset (do something), or wait (defer).
As you approach an expiring lease, the process could suggest you renew the lease (do nothing), relocate to a new address (do something), or allow the contract to expire and hope your owner doesn’t force you to vacate. By the way, with today’s obscenely low vacancies, I’d not suggest doing this.
A lessee considering a purchase could opt to renew the leased premises (do nothing), pull the trigger on the buy (do something), or wait until the nutty prices level (defer).
Unfortunately, solutions are rarely as straight forward as outlined above.
Using our income property sale situation, we first spend hours of analysis before finding a solution. Doing nothing and paying the taxes owed appears simple. But, when you consider Uncle Sam and cousin Gavin will clip an enormous chunk of your profit, this may pale in comparison to another route.
Doing something – by affecting a tax-deferred purchase and buying another parcel comes with myriad complexities. First, you must decide to do this before your sale closes. Next, there are finite time frames guiding your acquisition. And don’t forget, uou MUST find something!
Sellers are bullish. The pool of suitable offerings is limited. As Tom Petty crooned – “the waiting is the hardest part.” Deferring a decision – if you sell an income property – forces you into the “do nothing” mode. If you close without designating your desire to exchange, you lose the option. A fat tax bill awaits.
Now, let’s take the example of an expiring lease. Sure, you could elect to find a new spot. In effect “do something.” But the thinking behind the decision warrants some dissection.
Frequently we meet with a tenant and hear, “once our lease expires, we will DEFINITELY RELOCATE!” But, these days the majority of occupants don’t. After careful consideration, most realize renewing an existing lease has many benefits – an expensive move is avoided, disruption is nullified and downtime is erased.
The industrial real estate market suffers from an acute lack of available spaces. In some size ranges, our vacancy is zero! Your intention to upgrade into a newer facility might be met with very limited choices and costly ones at that. Finally, some just cannot pivot into a new address. Generally, we see such motivators as custom improvements, special permitting or an irreplaceable area.
A direction to purchase your business’ home and pay rent to yourself is a sound plan — sometimes. Doing nothing means you’ll stay, continue to rent and run your business with little change. Hopping into a purchase – doing something – would require you to survey the market, get yourself approved for financing or tap your piggy bank and execute a transaction.
Don’t forget to look into the “true cost of ownership” by adding up mortgage payments, property taxes, insurance and some little things like maintenance. It’s generally much cheaper to lease. Oh yeah, don’t forget: the down payment isn’t free – even if it’s in a liquid account.
You could choose to hire, invest in machinery or open a new market with the cash. In some cases, these alternate investments yield bigger returns than buying a building. Deferring until our pricing settles could make sense.
My opinion is we’re long overdue for a correction. But, so far, even a pandemic hasn’t stalled the upward march.
Sometimes FOCUSing on the solution is tough!
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at firstname.lastname@example.org or 714.564.7104.