Landlords should always be selling

February 19, 2023

Capital markets and investment demand are constantly in flux and out of your control. As an operator, it is your job to navigate the ebbs and flows regardless of market conditions. The primary goal is cash flow optimization, which becomes increasingly important in a rising interest rate environment. Not only do the capital markets shift, but tenant and consumer demand evolve, and so should your commercial property. Over the past decade, retail and office are two asset classes that have undergone significant changes in tenant and consumer demand. Layering-on asset price contraction, many owners are caught in an uphill battle.

When should you think about selling? Before you buy.

Shmuel (Shmulie) Siegel Siegel, Broker at WESTMAC Commercial in Los Angeles, is this week's feature on the Rockval Re:Cap. Siegel's bread and butter is retail and multifamily investment sales, but he has recently fallen in love with the office market and the new challenges the sector faces. He advises his clients to "always be positioned to sell." It is an easy concept, but as we all know, many landlords fall behind the curve.

The most easily identifiable inefficiency in today's market is office. Traditional offices with closed floor plans and cubicles are no longer in demand as many companies have fled to modern and amenitized product. As a result, landlords holding dated inventory are now staring at a possible recession and swelling vacancies. Unfortunately, this is the theme for most B & C Class spaces nationwide. Could this have been avoided if they followed the "always be selling" theory?

As a property owner, it is crucial to recognize the trends relative to your sector. The demand for a modern office space isn't something that happened overnight. Yes, the transition was accelerated by the pandemic, but following the principle of "always be positioning to sell" would have significantly reduced the risk of holding an empty building. By following this principle, property owners would have been proactive, upgrading and modernizing their facilities over time to maintain value. Instead, the office market is flooded with dated inventory, and many owners are in a predicament.

Adapt and Pivot

According to Siegel, many of his clients are debating whether or not to fully renovate their building or get out of the asset class entirely. However, if you decide to hold, there are a few ways to optimize your cash flow in the near term.

Repositioning your office building is always an option; medical services such as doctors and dentists still require office space and are good credit tenants. Healthcare practices continually seek to expand to new audiences and prefer retrofitted traditional office space because it is less expensive than ground-up development. Medical office leases tend to be longer to avoid relocation since their buildouts are physically unique and costly.

Attracting new tenants

Siegel has worked with several landlords debating renovation. He believes most people prefer to work in an office, and most businesses will return to the office in the next few years. He has recently worked through a few renovations proving his theory and landing his client's cash-flowing tenants. For example, one of his clients had a beautiful but dated property built in the 1980s. Although it was an attractive building, it needed to meet the modern layout of today's tenant demand. After renovation, he advised the client to offer short one to two-year lease terms. This does two things: it maintains positive cash flow and attracts tenants still grappling with a concrete schedule policy.

Being a Proactive Landlord

If you already have tenants, there are different ways to maximize your property's value. Utility costs have been rising nationwide, and depending on your property's age, it might be time for an upgrade. According to a report by ACEEE, a comprehensive utility retrofit can save up to 40% in energy costs. Updated to the latest lighting fixtures, gas, and HVAC systems are also great alternatives.

Shopping for new service contracts may seem tedious, but it can drastically increase your property's value. For example, if a property's current NOI is $100,000, but you find a more economical janitorial service that saves you $6,000 in annual expenses. Capitalized at a 5% cap rate, the $6,000 increase in NOI is a $120,000 increase in your property's value. Likewise, drilling down on ordinary expenses such as security, trash, contractors, and even paint can dramatically improve a property's terminal value.

The most important impact of being a proactive landlord is tenant retention. Even if your property is 100% occupied, 50% of upcoming renewals pose a major threat to the property’s income. Landlords should be active in maintaining tenant relationships and be willing to cooperate with their desires. In recent years, office tenants have desired more natural light, higher quality air, and more common space. The same goes for retail properties, as national and regional tenants are constantly opening or closing locations. To the landlord’s benefit, national retail store open/close rates are highly reported on and will allow you to be proactive instead of reactive in the case of a closure.

Re:Cap Key Takeaway

Owning commercial assets is risky, and there are factors in play that are out of your control. Therefore, aligning with the macroeconomic, microeconomic, and consumer trends influencing your property's value is critical. In addition to staying on top of the news, partnering with a proactive and knowledgeable broker like Siegel is equally important. Your broker can see through the "noise" and help advise you through a turbulent market.

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