The transaction world of Commercial Real Estate (CRE) can often be a long complicated dance between the seller and the buyer. Behind the scenes of the negotiation is a world filled with strategic partners and vendors that help the process move forward while assisting with the ultimate goal of completing the transaction. With this particular deal, I played the very fortunate role as a trusted advisor in both an asset management and commercial brokerage capacity.
Although the bullet points below are associated with one client and multiple properties, they were all pieces of one major transaction. Without the success of one, the others would fail. Following, is the anatomy of the deal:
· 3 Commercial Sales totaling $15.75 Million (2 retail centers,1 single family investment property)
· 6 Purchases totaling $27 Million (4 Medical office building, 2 office buildings)
· 2 1031 Exchanges (1 intermediary)
· 1 Reverse 1031 Exchange (1 intermediary)
· 3 Loan assumptions (2 separate lenders totaling $7 Million)
· 3 New Loans (1 lender totaling $7.9 Million)
· 1 Refinance (1 lender totaling $3 Million)
· 6 New single purpose entities
· 3 Law Firms
· 1 Property Management Company
· 1 CPA firm
· 1 California buyer
· 1 Nevada seller
· 35+ Strategic partners/vendors/advisors
The driving decision-
California, in all of its glory as the sunshine state, has dark clouds in the horizon as one of the most burdensome tax states. This reason, and the worsening condition of the tax structure, was the pivotal driver in divesting out of the California market for this particular client. This client was in the top California state income tax bracket of 13.3%. This means that in addition to paying Federal taxes of 39.6%, they were also saddled with an additional 13.3% state income tax. Although state taxes are deductible for Federal purposes, this client was paying an effective tax rate of almost 47%. That’s right, for every dollar earned, this client was paying close to 50% in taxes!
The evaluation phase of where the client was going to invest started with a twofold strategy. The first requirement was to look at income tax free or friendly states for real estate ownership. The second was to analyze what product type was preferable within the geographic region of choice. Initially we looked at multiple cities and states including Seattle Washington, Portland Oregon, Reno Nevada, Dallas Texas, and multiple cities in Florida. The client preferred multi family, but was open to other product types such as self-storage, mobile home parks and office. Tapping into a deep data base of contacts, analyzing multiple markets and eventually underwriting multiple properties and submitting various LOI’s led us to our final destination in Reno Nevada acquiring medical office and office buildings.
Nevada, and more specifically the Reno market, has been in the national spotlight over the last couple of years. Reno has experienced tremendous growth from new industries and companies like Tesla, Switch, distribution giants like Amazon, Barnes & Noble, Urban Outfitters, (the list goes on and on) Unmanned Aerial Vehicle (UAV) startups, and technology data center industry. The Reno market is currently surpassing previous market highs on all fronts including rents, employment, median wage and economic outlooks. The state has another hidden gem in the form of no income taxes! Therefore, due to its proximity to California, positive economic outlook and automatic savings of 13.3% in taxes, Nevada and more specifically Reno, was the top of the list for this clients divested assets in California.
The process of selling the two retail centers took almost one year to close from initial LOI to final closing. Although the longevity of the transaction had more to do with finding replacement properties rather than the sale transaction itself. The process started with finding the right co-listing agent. Leveraging CCIM relationships and after an exhaustive search and interview process, the decision was made to work with Mark Hinkins, CCIM at Hinkins Real Estate Analytics. Mark was very professional and expedient in his ability to bring a qualified buyer to the transaction. Within a couple weeks there was a full price offer for both assets by the same buyer. The buyer was a perfect fit, as he was able to purchase the property all cash and agreed to three (3), forty-five (45) day extensions to closing. Fortunately, the seller negotiated the options, as all three were exercised.
The lack of inventory in the Reno, NV market created multiple challenges for this deal. Although Reno, NV is experiencing staggering growth, it is still a tertiary market. The deals that were available were significantly over priced or asset types and/or locations out of the investors comfort zone. Additionally, the buyer was looking to acquire more than $25mm worth of assets. This proved difficult in a market that doesn’t have a ready supply of assets above the $20mm threshold. Although there were significant headwinds, we were able to come through for the client with an off market multi-property option. After multiple discussions with the seller’s representative, we were able to execute six separate PSA’s and go into contract.
Even though the negotiation to get into contract took quite a bit of finesse, what follows is what made this a very complex transaction. To accommodate the 1031 exchange, we had to establish six new single purpose LLC entities to own each property. We further had to determine the equity and debt basis of the relinquished properties to determine which new properties would be acquired by the relinquishing ownership entity. The existing debt on three of the properties could not be paid off due to the cost of the prepayment penalties. Therefore, the buyer assumed three separate notes, two from one lender and one from a CMBS pool. The assumption process proved to be a challenge from the start. After two weeks of delayed closing dates, we were able to get approvals and close on the remaining three properties. There were hurdles for the finance and refinance of the remaining properties, but after the dust settled, the lender was fantastic in providing a very competitive rate and term.
The Reverse Exchange
Shortly into the acquisition process, we made a recommendation to our client to add a property they were looking to sell into this transaction. Although it created more moving parts to the already complex transaction, it made sense for the client. Therefore, they used a reverse 1031 exchange to acquire one of the six properties, while simultaneously putting their single family home investment property on the market. Due to its location in the Bay Area and desirable attributes, the house was put into contract within two weeks. Upon completion of the sell, the reverse 1031 will be finalized.
The goal of being a problem solver, team player, strategic planner who listens to our client and finds the best solution was accomplished. Below are some takeaways based on the ebbs and flows of the transaction.
1. Time is always a factor– We agreed to a 30-day due diligence clause and 45 days to close on the purchase of the six assets. Although we negotiated an extension for the assumed properties, we did not for the non-assumption properties. Fortunately, the seller was willing to work with us on the small delay.
2. Know your lenders requirements – The lender for the three non-assumption assets and the refinance was very keen on knowing everything about my client. They required all entity and trust documents not only associated with the purchase but outside of the purchase as well. They were extremely thorough on their underwriting. This thoroughness allowed us to get one of the most competitive rates for the client.
3. Assumptions cause delays and are costly- The assumption process can take 60 days or more. Even though you are assuming an existing note, the servicer is still underwriting the assumption as if it was a new client. Additionally, there is always a fee associated with an assumption. Normally that fee is 1% of the outstanding principal balance. Be careful as to understand what the additional fees are. Related fees like legal fees, mortgage broker fees (from the original transaction) title and escrow fees associated with the assumption can add up!
4. Patience is key- With so many moving parts and so many different vendors to work with, something inherently always goes wrong. Have contingencies in place and patience with the process.
5. The team is everything- A deal of this size and complexity requires a great team. Therefore, I would like to give a special thanks to all that were involved.