By Philip D. Voorhees, Vice Chairman, CBRE
During more than 730 retail investment transactions in the Western U.S. totaling more than $11 billion, we’ve identified some sure-fire ways to make an already tough retail investment sale transaction even more challenging. Our pain is your gain. In the cases below, we’re giving you the test after the lessons!
Philip D. Voorhees
1. Move Slowly, and Lack Urgency.
Nothing kills a retail investment sale transaction like a lack of urgency. All too often, sellers fail to have a Purchase and Sale Agreement (PSA) ready when an agreement is reached on the Letter of Intent (LOI), subsequently squandering a week or two while their attorney completes the draft PSA. It can also be difficult to circle the partners to obtain consensus on the next action step if you don’t have a “point” person designated as the lead for a partnership. Sellers will oftentimes mirror slow PSA comment turnaround times from a buyer, assuming the stance that, “if the buyer is slow, we’ll take our time, too.” This makes no sense: Eyes on the prize, sellers!
Solutions:
• Approve template LOI/counter proposal and PSA drafts early in the marketing process.
• Put legal counsel on standby when agreement on an LOI is imminent. Countless times each year, PSAs are delayed due to legal counsel travel. This is not acceptable. Expect more. Do not settle for less than promptness.
• Aim to turn around all documents/responses in 48 hours; 72 hours for PSA comments.
• Act like days count – because they do! For example, we once had a transaction that involved a tenant paying more than $200,000 per year who declared bankruptcy days before the transaction’s closing. They announced plans to close the store at the property being sold, which triggered a material adverse change provision in the PSA. Don’t let this be your problem!
2. Skip Preparing Prior to Listing the Property for Sale.
Smart sellers do not wait for the marketing train to leave the station. Rather, they plan early for the trip. If you plan to sell during the next calendar year (or a given period of time), do the following:
• Act like a buyer. Study your rent roll for near-term (one to two years out) lease expirations and seek early renewals that can strengthen your property’s value and mitigate potential buyer concerns.
• If tenant leases require sales or financial reporting provisions, ask the tenant to produce these documents in advance. When selling, ignorance is not bliss. It’s better to know about and solve objections in advance than to be caught off-guard mid-transaction.
• Address ADA, roof and HVAC issues requiring attention.
• Clean-up aging/receivable accounts. Tenants with big AR balances should be addressed.
• Settle tenant complaints or grievances to improve tenant interviews.
You get the idea. If you fail to prepare, you are preparing to fail.
3. Skimp on Third-Party Reports.
If you are fortunate enough to own or control a multi-million-dollar retail asset, act like a pro. The best institutional investors know better than to skimp on the cost of third-party reports. They don’t try to shift this nominal cost to the buyer. Be smart! An American Land Title Association (ALTA) survey costs $1,500 to $7,500 in most cases, and a Phase I environmental report seldom tops $5,000. If you do not have fresh reports from a reliable, “brand name” regional or national firm, you have all but ensured at least a 21-day (if not a 30-day) due diligence period, from the date of the PSA execution in order for the buyer to complete these reports. If a report does uncover a problem, the deal timeline increases in a best-case scenario. The worst-case scenario is the deal is derailed, causing re-marketing.
Solutions:
• Upon executing the listing agreement, order an updated ALTA survey and a Phase I environmental report when you sign the listing agreement.
• Request a reliance letter or assignment provision whereby, for a nominal fee, the next purchaser can have the report(s). Not all lenders or buyers will accept this. REITs, pension funds, advisors and lenders often require reports from their own firms. Though, it takes these items off the table from a due diligence standpoint.
• Consider ordering a Property Condition Assessment (PCA). Worst-case scenario, it’s a preview of coming attractions on items that an informed buyer may seek to retrade at the end of the due diligence/contingency period. If the report is “clean,” you can furnish the buyer with a copy, along with the counter proposal!
4. Be Your Own Attorney (or Use a Non-Real Estate Attorney or “Standard Form” PSA).
Friends don’t let friends use “form” PSA agreements. Good grief! Don’t be penny wise and pound foolish. You are a real estate mogul owning a property worth millions. Hire a real estate attorney to represent you. One of my first deals in the business was representing an outstanding guy and sage investor from Long Beach, Calif. He was a retired real estate attorney, and I was surprised when he referred me to his attorney to get the PSA. I asked him why he would hire an attorney when he was a real estate attorney for more than 30 years. He looked at me earnestly and said, “Phil, I read a PSA every couple of years when I buy or sell. There are attorneys that read five or six a week. Who do you think is going to be more current and do a better job?” Fred was one of the greats. (You don’t see real estate attorneys using PSA forms, do you?) Be like Fred and hire a proven real estate attorney. A PSA can run as little as $3,500 or as much as $50,000 on the most complex transactions.
5. Conceal Challenging Items from Your Deal Team.
Don’t hide prior environmental issues, the missing NFA (No Further Action) letter, tenant roof leak issues, violated exclusive use provisions, landlord lease defaults, intentional or otherwise, or unpaid tenant improvements (TIs) or leasing commissions (LCs). From our team’s experience during more than 730 successful retail closings, these issues invariably come up at some point during the transaction. When they do, no one is happy. This is a great opportunity to recall the Golden Rule: Do unto others as you would have them do unto you. Take the high road. Be transparent. Own your outcomes.
6. Do Not Cooperate with Brokers.
“I hired you to sell my property, why would I consider paying for another broker to bring me a buyer? Isn’t that what you are supposed to do?”
Pre-2001, approximately the year the internet penetrated the brokerage community, real estate investment sale transactions were a much more local business. With the advent of the internet, however, and, equally important, the arrival of Google Earth and various mapping software, understanding a trade area or market previously remote to a buyer became much easier. With these events and the rise of 1031 exchange-motivated capital, the pool of potential investors for a given asset grew exponentially. Present day, the simple fact is it would be impossible for a broker to know every potential investor, particularly when private capital investors only enter the market intermittently.
From our team’s experience, the best way to reach private or new capital entering the market is through a broad, cooperative marketing process. Offering a compelling co-broker fee on your listing is a cheap insurance policy to ensure your property is marketed widely and in a manner that activates the brokerage community. As a seller, you would make the co-brokered deal only if doing so produces a better net result: a compelling proposition. The competitive, co-brokered offer can oftentimes push the dual representation/lower-fee-offer to a better price, also improving net proceeds to the seller.
7. “We can Parcelize it While Marketing…”
No, generally speaking, you cannot. Best case scenario, it takes 90 days to get a new parcel map surveyed and recorded. If doing so requires amending or creating Covenants, Conditions & Restrictions (CC&Rs) or the Reciprocal Easement Agreements (REAs), this process can take six months to a year in many municipalities. By way of example, suppose you have a pending Chick-fil-A LOI on a pad that is not yet parcelized. If the pad already sat on its own parcel, the parcel could be held back from the transaction until the lease was perfected, the building built, etc., and sold at a “market” cap rate that is likely lower than for the entire project.
However, if the parcel is part of the larger center, and if the Starbucks lease is a build-to-suit (which can easily cost upwards of $1.25 million to complete), a seller cannot easily realize the profit/upside unless the buyer agrees to an “earn-out” scenario. For this reason and because maximum parcelization also provides financing flexibility, CBRE advocates mapping properties for as many parcels as is practical prior to marketing.
8. Model Income Not in Place. You Can Use Seller Rent Guarantees
Situation A: “I’ve got an LOI that is nearly signed. It’s going to add $40,000 of NOI. Let’s model it and I’ll cover the costs and backfill any income shortfall before rent starts.” Situation B: “This 4,000-square-foot space has been vacant for four years, so I’m just going to master lease it for a year or two. You can cap that income, right?” Answer: NO in both cases.
Present day, seller “master leases” on vacant spaces do not fly unless (1) the seller is really going to use the space and will sign a lease; (2) the seller backs the lease with credit or a personal guaranty; (3) the lease term is three to five years; (4) rent is at or below market; and (5) the space is in reasonable, marketable condition and not functionally obsolete. Think of your master lease more like a sale/leaseback than a temporary income plug and you will get the idea. Even on a legitimate seller master lease, expect scrutiny from investors and lenders.
As it pertains to “pending” deals in current market conditions, few investors are interested in purchasing a partially baked cake: only done is done. From a buyer’s perspective, if the income is a “maybe,” it’s a “no.”
To this extent, an “earn-out” scenario – where the seller gets paid for adding the value once the value has been added – makes the most sense. In a more speculative scenario, where the LOI is not yet signed and lease negotiations have not begun, extracting any value is not realistic. Worst-case scenario is an owner goes to market with a “pending” lease that falls through, sending net operating income (NOI) downward and shaking investor confidence in the asset. Depending on the percentage of gross leasable area (GLA) in play, a failed lease can force a restart of the marketing process.
9. Go on Vacation at Critical Points in a Deal.
Once upon a time, we were mid-transaction on a roughly $30 million center. The seller took more than two weeks to get an LOI negotiated due to partner approval and subsequently took another three weeks to generate the PSA. The buyer turned the PSA comments in less than a week; not speedy, but not unreasonable either. The seller then said, “I’m on the road this week, so I won’t be able to review until next week.” WRONG! This is where your attorney comes in. No seller should spend time reviewing first-round PSA comments unless they really enjoy doing so. This is simple: Forward the PSA to your attorney and ask for a summary and recommendations. The deal keeps moving while you are gone. Time will not kill all deals, but it definitely kills some. “Market” timing to negotiate a PSA is 10 to 21 days for reference purposes.
10. Put Your Ego on the Line: It’s Personal.
Are you operating like it is a “seller vs. buyer” world? Who is tougher? Who is the cagier negotiator? In a seller’s market, it’s possible to get away with a cavalier attitude but, in case you missed the headlines, buyers may presently have more leverage on retail transactions than at any time over the past several years. The most astute sellers maintain a level head during a transaction. Refer to the Golden Rule. The extra time you grant, or the small, good faith gesture made early in the transaction can be the favor returned when you need to request an accommodation later in the deal. It’s a small world in real estate investments, and it seems to be round!
While these are just a sampling of the best ways for a seller to screw up a retail investment sale transaction, countless others exist. Don’t consider this a complete list – and do your best not to add to the list! Take good care, sellers, and best wishes for successful closings on all your retail investment endeavors!
This article first appeared in the January 2019 edition of Western Real Estate Business magazine.