CEO's can benefit from the current downturn in commercial real estate as prices drop.

Jerry Lehman
CEO, president and principal broker
Lehman Realty Services

How long the downturn in the commercial real estate market may persist is uncertain, but the trend presents longer-term financial wins for opportunistic CEO's. Historically, the local commercial real estate market has escalated despite a few dips, downturns and plateaus along the way. The current slowdown in residential real estate is impacting commercial real estate, and that offers CEO's who plan to continue operations in South Florida the opportunity to purchase or lease property at reduced rates.

“We are currently in unchartered waters and no one is clear on where the commercial real estate market is headed in the near term, but if history is any indication, the long-term market will most likely tell a very different story,” says Jerry Lehman, CEO, president and principal broker for Prudential CRES Commercial Real Estate SFL. “Now is a good time for CEO's to look at space requirements and negotiate deals because it’s quickly becoming a tenants’ market.”

Smart Business spoke with Lehman about what’s driving the current trends in the commercial real estate market and where the opportunities lie for CEO's.

What are the drivers that are affecting the current commercial real estate market?

There’s a great deal of turmoil among commercial mortgage-backed securities lenders. Spreads have gone up between the loan index and the desired note rates and the general consensus in the industry is that higher interest rates are having an impact and we’re seeing it reflected through lower sales prices. The commercial real estate market in South Florida has been sizzling hot. The current cooling off period is bringing back more of a balance between supply and demand, and that will help to eliminate overpricing and start raising capitalization rates.

What sector of commercial real estate has been hardest hit?

During the prior boom period, vacant land was allocated toward residential uses for homes and condos. In turn, new housing creates demand for commercial property that is zoned for shopping centers. The residential construction frenzy meant that less land was allocated for office buildings and warehouses. Now, everything has changed. The condo market is deader than dead and the overall slowdown in residential building is freeing up land for other uses. Also, commercial vacancy factors have risen sharply. The overall slowdown in the economy is having an impact on the market for office and warehouse space, which is, in turn, reducing leasing and purchasing costs. If CEO's are thinking about building offices for the future, now’s the time to consider such a move because owners are becoming more realistic about pricing office space for sale or lease and construction prices are dropping .

Are commercial deals still being done?

Yes, commercial deals are still being consummated but much more selectively. Part of the reason for this is that although long-term rates have been falling, spreads have increased. Last year, spreads were as low as 100 basis points, now the spreads are 100 to 200 basis points higher. Higher interest rates mean lower sales prices, and that’s good news for opportunistic CEO's.

With less demand for residential construction, where is the demand shifting?

During the last flurry of residential construction, developers mainly ignored office and warehouse construction and, when the downturn hit, the developers shifted their attention to office and warehouse construction. The new target for this downturn is apartment development. With tougher credit guidelines and increased foreclosures, the demand for residential rental units is up sharply and developers are responding.

What do you see for the near future?

Fundamentally, lenders want to lend and the market will correct itself once again and the housing demand will return. The population continues to grow as the migration to South Florida continues. The absence of hurricanes has lowered insurance premiums and real estate tax relief will encourage more people to relocate to the area. Creation of high-paying jobs, like those in the high-tech field, will place more of the residential real estate within the financial reach of the burgeoning population. I’ve been through many of these cycles, and I know that it can take two years for the correction to work through the market. But, the bottom line is that it always has. I think that the stronger credit required by lenders for portfolio loans has created a situation that makes the collapse of the commercial real estate market highly unlikely. As the economy improves and the demand for offices and warehouses increases, rental prices will escalate. It’s hard to say where the cycle will go next, but one thing is clear — there will always be a future in real estate because the development of America continues.

No matter how dark the cloud may seem, there’s always a silver lining. For those with good credit and good investment sense, the silver lining just might be the abundant opportunities in the commercial real estate market. Banks, reeling from the credit crunch, have money to lend and need to rework their books of business. With underwriters on the hunt, creditworthy borrowers should be searching for good properties if they want to take advantage of the current opportunities in the commercial real estate market.

“Banks need to lend, but they want quality deals,” says Jerry Lehman, CCIM, SIOR, CEO, president and principal broker of Prudential CRES Commercial Real Estate SFL. “Interest rates are close to all-time lows, and the liquidity crisis on Wall Street has had a major impact on the commercial real estate market. This is an opportune time to look at investment properties or leasing space.”

Smart Business spoke with Lehman about the impact of the liquidity crisis on the commercial real estate market and how savvy investors can capitalize on the current opportunities.

How has the Wall Street liquidity crisis created opportunities in commercial real estate?

Many Wall Street firms are reeling from losses in the subprime residential mortgage market. These firms began pulling out of commercial mortgage commitments in order to protect their cash and liquidity. Also, many individuals with large amounts invested in money market auction-rate bonds were shocked to find that their funds couldn’t be withdrawn because the market for these bonds disappeared almost overnight, freezing the money market deposits. All of these events have had a profound impact on the commercial real estate market. There are more sellers than buyers, prices have fallen and lending rates are favorable. For investors or executives that have a specific real estate need, investment goals and good credit, the opportunity to make a deal has never been better. While there’s less competition for good buildings, there are also fewer lenders funding deals because the institutional lenders are virtually gone.

What are the best deals right now?

Multifamily residential properties are currently good investments. With many families losing their homes, vacancies are on the decline, so apartment buildings are attractive right now. Also, small and midsize industrial buildings, anything under 50,000 square feet, are a good investment because there’s always a shortage of those on the leasing market, so you’ll generally have no problem finding tenants. Office buildings currently have higher vacancy rates than normal because many real-estate-related businesses have closed. But if you can hold onto the property for a while and ride out the current economy, it will be a good investment as the occupancy rates improve. The best value of all is vacant land. Owners are desperate to sell, but vacant land is definitely a longer-term hold. So if you invest in vacant land, plan to keep it for a while.

What are the current lending qualifications?

You’ll need 20 to 25 percent down and good credit. It certainly helps if you come into the bank and open a new account because new depositor relationships will garner a more favorable rate. You’ll also need strong company or personal financial statements, and the cash flow of the property you’re considering needs to be favorable. Banks want quality properties and quality deals right now. Quality properties are defined as those with a good location and good demographics for the specific use. For example, if the purchase involves an industrial or office building, they’ll consider the location, cash flow and the strength of the tenants in assessing the deal, and they’ll also consider the physical condition of the property.

What professional support and relationships will investors need?

Even if you’re conducting a small transaction, it’s advised that you are assisted by a lawyer and accountant, but you’ll surely need that type of professional support to act as an advisory team for larger transactions. If you have a current banking relationship, it’s helpful, but if not, a qualified broker with solid community relationships should be able to refer you to a lender. Also, make sure your broker understands the marketplace and your needs so they match you with the right property for your budget and your investment goals.

How pre-sold commercial conversions can benefit buyers and sellers

Jonathan H. Lehman
Legal Counsel
Prudential CRES Commercial Real Estate SFL


Almost every executive is or has been impacted by today’s economy and real estate market. But, many developers are finding relief by converting existing commercial properties to condominiums.

When a property changes from sole ownership to individual unit ownership, developers can reduce risk by securing commitments from unit buyers before even acquiring the title to the property, which appeals to purchase money lenders, and there may be little cash required to finalize the transaction.

“By converting to condos, developers turn otherwise un-noteworthy rental assets into property that becomes attainable for would-be buyers,” says Jonathan H. Lehman, legal counsel for Prudential CRES Commercial Real Estate SFL. “The event of converting is especially appealing when a buyer is involved in the condo creation.”


How do conversions benefit developers?

When developers secure condo unit buyers and acquire a property simultaneously with the condo conversion and sale of units, there’s minimized risk of unoccupied real estate sitting on the market for a long time. Developers can assure lenders and secure financing accordingly. A properly executed simultaneous conversion produces equity from the sale side for immediate application toward the acquisition side, as opposed to new construction, where developers face a major capitalization requirement. These conversions require only the difference of cash-to-close minus condo sale proceeds, if such a differential exists. Developers stand to walk away with a substantial profit and they could be in and out of the transaction relatively quickly. With residential condo construction, buyers are asked to buy on speculation and developers could be tied to a project for years. Also, non-residential conversions face little or no governmental review.

What are the benefits for unit owners?

Individual unit owners who have leverage by way of tactful contract negotiations can insist on being involved in the initial set-up of the association and the drafting of the governing documents, which isn’t on the table when buying in an existing condominium. Owners get more control and input opportunities, from voting power and assessments to rules, regulations and signage. When units are pre-sold prior to conversion, owners reduce the risks associated with purchasing a unit in an undersold project subject to developer solvency. Those currently leasing space have the opportunity to switch rental expenses to real estate investments, which could pay off well once the market rebounds.

What are the steps for converting?

A developer involved in a pre-sold commercial condominium conversion must:

• Assemble professionals. A conversion is law intensive and there are many considerations that must be reviewed with your lawyer. Your broker can assist with marketability and prospective profitability based on local comparables. Also, surveyors, engineers and other specialists must be retained to complete the project. As with any real estate project, make sure your professionals will commit to your budget and time frame.
  
  
• Identify the right property. Find an existing building that has uniformity of space, so it will divide easily and equitably, and be conducive to multi-unit access. Targeting a specific clientele is an option, but it must be permissible in the jurisdiction and practical with respect to market absorption. Having ‘Class A’ construction is helpful because it appeals to condo buyers on an emotional ‘gotta have it’ level. After all, the necessity for a developer to contribute capital and time toward improvements diminishes the attractiveness of this type of project and threatens to interfere with a fragile time schedule.
  
  
• Run a financial analysis. Run a market analysis, set prices for the units and be certain the sum of the parts will be greater than the total cost. Aim for enough capital through pre-sale activities to close on the acquisition. Be wary of small concessions to buyers because the aggregate cost could equal a significant blow to the bottom line.
  
  
• Secure buyers and draft documents. Focus on selling units to effectuate the simultaneous acquisition and conversion. The quality of the buyer and likelihood of closing on time are important considerations. Negotiate and draft the governing documents and make sure the buyers will be properly represented in the association. In some cases, the developer will have to act as an umpire to balance the long-term sustainability of the condominium where separate unit owners are inclined to push for control.

Proceed to the close. At closing, your lawyer can facilitate the acquisition closing, condo creation and unit re-sale closing.

Is there a downside to conversions?

If a key party defaults, which is largely out of your control, there’s always the potential to lose money on the project and face repercussions. The reality exists that the market may not have yet bottomed out, and unit owners could experience a loss in the value of their units after purchase. The entire scheme is not cheap: the developer will, among other things, get hit with double closing costs, whereas the buyer will likely need cash to close. Both developers and unit purchasers should consult their accountants to assess further financial disadvantages.

Building a national company is the dream of many entrepreneurs, but launching a new franchise or opening a distributed group of sales offices means securing real estate in new areas, and that requires knowledge of the local market.

In the past, many executives created infrastructure and hired staff to procure and manage commercial real estate as part of an expansion plan, yet those staff members often turned to local real estate brokers for marketplace expertise. Now, smart CEOs are finding they can secure the knowledge without the overhead by outsourcing their company’s real estate function.

“Operating a national real estate portfolio can be overwhelming,” says Jerry Lehman, CCIM, SIOR, president and broker for Prudential CRES Commercial Real Estate SFL and executive vice president for Prudential CRES National Services Group. “It’s time-consuming and it’s expensive. No matter the size of the company, if your reach moves beyond your local neighborhood, it’s possible to outsource everything from site selection to lease management without increasing costs.”

Smart Business spoke with Lehman about the advantages of achieving growth without increasing overhead by outsourcing your company’s real estate department.

Which commercial real estate functions can be outsourced?

The entire scope of the real estate department can be outsourced, including market surveys, initial site selection, the due diligence process, property inspections and ongoing lease management. The services can also include monitoring lease expiration dates, negotiating lease renewals and conducting day-to-day communication with landlords about needs like increasing the parking spaces at a remote sales office. Many national commercial real estate companies offer turnkey outsourcing programs.

What are the advantages of outsourcing?

Real estate is a local business. While you can review local area demographic data such as population, income and age when considering a new location, selecting the perfect spot requires a composite analysis of data and human intelligence. Unless you’re familiar with the local market, you won’t know about recent changes in property use, new roads, proposed exit ramps or if employers are leaving the area and why. The most critical player is the local agent who must understand your business needs and match them to the local market. In most cases, internal real estate staff members will turn to local agents for that knowledge and expertise, so outsourcing further leverages your buying power, reduces overhead and gives you a committed relationship with a national network of agents located in major urban and secondary markets. While you’ll work with a number of agents, you’ll have one contract to manage and you’ll work through the company’s account managers and regional directors. They’ll become experts in your business, your real estate needs and your long-term business objectives and then transfer that knowledge to the local agents, when you need to secure a new location.

What are the costs and the potential savings?

There’s no cost to your company because the landlord or seller pays agents’ commissions. The result is a huge savings opportunity; at most, you might need a small internal team of one or two people to manage the outsourcing relationship educate the account managers about your business requirements and manage your company’s portfolio of leases. I’m familiar with one large retailer that manages a portfolio of 1,600 store locations with an internal staff of only three people. Without outsourcing, it would take a minimum of 50 people to manage a global real estate portfolio of that size.

Will outsourcing change the fiduciary relationship between brokers and clients?

If you choose to outsource your company’s real estate department, the broker’s fiduciary relationship will remain with you, the buyer. Typically in a real estate transaction, the landlord or the seller pays the broker’s fees, so the industry standard is that others pay the costs associated with the broker. The party who pays and the agency relationship are not necessarily related in commercial real estate transactions.

What selection criteria should CEOs consider when selecting an outsourcing partner?

Select a company with a strong geographic reach and extensive commercial real estate experience, because you want to select a partner that has some muscle in the field and the resources to manage an outsourced engagement. Review the company’s locations to make sure it has an office in the cities and countries where you plan to expand. Understand their account management structure, because once the contract is in place, those people are vital to the success of the relationship. You’ll want to know if you’ll have a single point of contact and how they communicate information about your needs to brokers located across the country or the world. Consider checking references to validate a potential vendor’s experience and commitment. Then sit back and enjoy the benefits of growth without the expense.