Watch out for a "hair-cut". Price reductions in the middle of a sale...

Sellers…Ready for a haircut? The increasing phenomenon of “re-trading”

In an environment where investment property sales have plummeted in the Sacramento region approximately 75% or more over the past year, any Seller who has a property in escrow must be prepared for the growing phenomenon of “re-trading” a “hair-cut” or a “price reduction” that is taking place and is prevalent with almost every transaction these days.

The phenomenon of re-trading is also categorized as a “haircut”” or “price reduction.” It typically occurs when the property is in escrow, during some point of the Buyer’s due diligence process. Perhaps some sort of unanticipated or unexpected property defect is discovered whose repair/update requires significant additional dollars , or the amount and type of financing that the buyer expected to achieve is not possible or requires additional buyer equity. In this tightening credit market, these issues are no longer a remote possibility, but instead a daily market reality.

The end result is that the Buyer asks the Seller for a “price reduction”, after having spent a certain amount of time having the property tied up in escrow. No buyer or broker for that fact likes it, but in this market, it is more inevitable than ever. Our advice to most clients is “don’t take it personal” it doesn’t necessarily mean that the Buyer “isn’t ethical and dealing fairly” – most often it is a reflection of the tough times that we are in…

How does a Seller minimize the probability of a haircut when selling a property?

The more certainly a Seller can provide a Buyer up front in regards to the condition of the property, the better. Oftentimes, this may mean the Seller may pay for key inspections such as a roof inspection or a Phase 1 environmental report prior to bringing the property to market to understand the property condition and disclose any issues to Buyers up front before they have put the property in Escrow. It may mean some up front costs, but it goes a long way in defining the scope of any potential problems to potential Buyers prior to putting the property in escrow. Having accurate records regarding income and expenses, square footages, rent rolls and etc is also very essential.

Also, we as brokers know that counseling a Seller on choosing the correct buyer is really an art. Despite all of the Seller’s best efforts in doing so, there are occasions, now much more frequent, that require a buyer to say, “Oops, sorry, for XYZ reason, I can only pay this reduced amount.” As brokers, we counsel our seller clients to accept deals based on a combination of 3 primary factors. First, it is what PRICE the buyer is willing to pay. Second, it is the TERMS of the deal (how long the due diligence takes, any contingencies in place), and third, it is the Buyer’s ABILITY TO CLOSE. It is oftentimes not the Buyer who is willing to pay the highest price who will come through at the end of the day. Reputation on previous transactions is key variable.

Sellers have to understand that in a rapidly declining market, which seems in the short term to be getting worse, gone are the days where a Buyer who wants to change the terms of an agreed-to deal is substituted for another Buyer. Many negotiations are extending into and during the escrow period, with Sellers and their brokers working to keep the existing Buyer engaged and committed rather than disappearing. In this market, time or delays, kill all deals or certainly increase the probability of a haircut. Brokers and sellers as well as lenders, inspectors, attorneys and escrow agents have to work with a heightened sense of urgency. A prompt closing with a pre-qualified buyer and completed due diligence package on the property is the best defense to a “hair-cut”.

If you are ever faced with the issue of retrading as a Seller, take the time to think through all of your options and strategies. It is a normal reaction to become mad by the request to change the financial terms. But, sometimes, your best option is to continue to keep riding the horse you’ve chosen, taking a “little trim” if you are lucky, and helping the Buyer get over the finish line. Ultimately, this response may result in you achieving your objectives or the majority of your objectives of disposing of your asset more quickly rather than starting from scratch with someone new in a falling market.

If you would like to discuss this blog post with us or if we can help you with a commercial or investment real estate transactions, please call or email us at Jim Gray (916) 617-4255 jgray@naibt.com or Nahz Anvary (916) 617-4257 nanvary@naibt.com. “Build on the power of our network” visit our website at http://www.naibtcommercial.com/

Investment Sales Slow in USA and in Sacramento

Investment sales slow dramatically…

My current line when people ask me “how is the commercial real estate business?” is “It’s fine but I get to sell properties 4 or 5 times before they actually close”. This is because buyers are pickier, sellers are confronted with a changing market and lenders are tougher when it comes to underwriting real estate loans. The indicators are clear and we feel it as active brokers in the business--Investment sales have slowed down considerably. The National Association of Realtors reports that “Investment in commercial real estate during the first 4 months of 2008 was $48.2 billion, down 69.5% from the $157.8 billion for the same period in 2007. More at http://www.realtor.org/press_room/news_releases/2008/commercial_index_contracts

And here in the Sacramento Region, the Sacramento Business Journal reported “Real Estate investment tumbles; sales happening, but at a slower pace.” The Business Journal reports that investment sales are off 2.1 billion or 58% drop for the past 12 months. More at http://sacramento.bizjournals.com/sacramento/stories/2008/08/04/story5.html

Clearly volume is down, but deals are still getting done. For the first 6 months of 2008 14 office investment properties have been sold and that contrasts to 56 transactions for the same period in 2007.

The slowdown is attributed to the overall decline in the economy, to a tighter credit market with stricter underwriting in which lenders are requiring higher down payments plus higher interest rates and personal guarantees from buyers. A number of lenders have left the market all together. Also a number of prospective buyers are waiting and assessing what is happening to operating expenses, rental rate growth/decline, and to potentially higher cap rates.

We agree that this market is slowing, but we believe it is not going to be like the savings and loan collapse of the late 80’s. There has not been that much over-building , and most properties are still generating positive income and cash flows for the current owners. Sure, there will be some investors who will get into trouble and will need to dispose of properties that were bought at the top—that haven’t hit their proformas and likely have short term debt or adjustable rate debt who will have a higher sense of urgency. Sellers who want or need to sell will need to be realistic about their price and their deals will attract buyers with more cash seeking higher yields – 7% to 8.5% cap rates on actual Net Operating Income – and underwriting and conditions of financing will make transactions harder to get funded and to actually close.

If you would like to discuss this blog post with us or if we can help you with a commercial or investment real estate transaction please call or email us at Jim Gray (916) 617-4255 jgray@naibt.com or Nahz Anvary (916) 617-4257 nanvary@naibt.com.

To Sell or Not to Sell? Capital Gains Considerations is that the Question?

To sell…. or not to sell? That is the question.

If you have been following the presidential race as closely as we have, one question may be at the forefront of your mind—to sell…or not to sell? Borrowing William Shakespeare’s famous line and applying it to the world of commercial and investment real estate has made us wonder about the role capital gains tax and the outcome of the upcoming election may play in our disposition decisions and what the best avenue may be to reinvest our proceeds from investment property sales.

The volume of 1031 tax-deferred exchanges has dropped dramatically, approximately 30-50% in the last year, especially in properties less than $5 million, according to Boulder Net Lease Funds. One explanation may be that investors who once never dreamed of paying Uncle Sam are now deciding to lock in their gains, as no one is really sure when capital gains rates may ever be this low.

Regardless of whoever takes the White House in November, it seems to be a matter of time until the very favorable capital gains tax rate of 15% is set to increase.

So…if you have been philosophizing about the big question “to sell…or not to sell” you may have just found your answer. Or at least you are asking the right question along with many other investors.

For more, read the article in the Wall Street Journal, June 18th, 2008, Your Tax Bill How McCain and Obama Differ; Capital Gains Rates are likely to Rise, No matter Who Wins.
http://online.wsj.com/article/SB121374794468982701.html

National Real Estate Investor, June 2008, Taking a Direct Hit.
http://nreionline.com/finance/investors/real_estate_taking_direct_hit_0601/index.html

If we can answer questions about this posting or help you with a real estate question or decision please feel free to call Jim Gray or Nahz Anvary at NAIBT Commercial Real Estate at (916) 617-4255 or (916) 617-4257.