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Convert And Upgrade For A New Potential March 2018 One of the ways to increase income taken care of by routine repairs and and value is to upgrade an older prop- replacement of parts. Anytime the This publication is not erty. In every community, anyone who acquisition of a run-down building a solicitation but is an information service from looks can usually find a number of is being considered, the investor this office. commercial buildings, apartments or must be certain that the deteriora- offices that need to be modernized. tion has not become so bad that Some are for sale because the present the building will have to be demol- owner may not recognize the increased ished. In This Issue return that they could get or do not Functional obsolescence happens want to make a further investment. when the loses its useful- • Convert And Upgrade The property might be purchased at ness as a result of changes in styles For A New Potential a bargain price that is based on the or in the needs of tenants. As an • The Land Under A current cash return. example, an older apartment prop- Don’t overlook that are erty could have an electrical system Business–The Most still productive, but may have a much that is inadequate to handle modern Valuable Asset greater potential after a conversion. appliances such as air conditioning, • Considerations In Factories have been converted to shop- microwave ovens, computers, tele- ping centers all over the country. Old vision or other recently developed Ground Leasing Movie theaters have been converted equipment. This type of obso- • Restructuring to multi-screen facilities. Garages lescence can be cured usually by Troubled Property have been converted to condominium installing updated equipment. parking buildings. Seeing potential Economic obsolescence is a change • Commercial Real profits in older buildings takes imagi- in value that is caused by circum- Estate Representation nation. stances that are not directly related When you set out to upgrade an older to the property. Often this is a building, you will encounter either change in the neighborhood, such deterioration or obsolescence. Physical as a change in the use from resi- When ideas in tax and other legal areas in this publication deterioration, starts immediately dential to commercial or industrial. seem to fit your situation, after the building is completed and When this has happened, modern- it is recommended that you continues throughout its entire life, ization of the building may not be discuss them with your unless it is handled along the way with worthwhile. If the building is struc- professional advisor before taking action. proper maintenance and repair. This turally sound, it could be a good type of deterioration usually can be prospect for conversion. ß (continued)

Ways To Upgrade older apartment buildings in good neighborhoods There are several ways used to upgrade a building. often look better for a long-term commitment than new construction. When a property is modernized, When a building is quite old, structural changes may rents can be raised substantially and, if the work can be needed for safety reasons. Before you purchase be done without disturbing the existing tenants, the the building, a professional engineer should make an investor will not have the expense of carrying the inspection. This can determine whether the building property as he/she would in new construction. He/ is structurally sound and what changes, if any, will she would also hope that most of the existing tenants have to be made. would stay and pay the increased rents, so the costs The building can be partially redesigned with archi- related to acquiring new tenants, as would be needed tectural changes during the modernization. If a with a new construction, would be avoided. building has very distinctive architectural features Finally, the overall costs may be less. Although the rather than a plain exterior, some investors feel that price of the property may be high in relation to the the property has a greater investment potential. current rents, the final cost after modernization may Functional changes and mechanical replacements be far less than the cost of new construction. With can reduce costs in an old building and increase effi- this lower cost, the investor may be able to charge ciency. Wiring will usually need to be replaced to lower rents than new buildings nearby, putting her/ provide safety for modern electrical and computer him into a very competitive position. equipment. Old heating systems will usually be inef- Convert To A New Use ficient and cause high maintenance costs, and should be replaced. An example of a mechanical replacement Unproductive properties can present opportunities would be a change from an old, slow elevator to a for big profits. When a building is bringing in little modern one. or no income because obsolescence or because of changes in the neighborhood that have made the loca- Aesthetic improvements are the sprucing up of the tion unsuitable for the original use of the building, property and can usually be done at a relatively little converting to a new use can make a new profitable cost. When an investor is looking for a quick resale, income stream. As an example, a movie theater in this type of improvement may be done rather than an area converted to industrial might be changed some of the others. Cleaning up the property, inside to a factory or warehouse. Some neighborhoods and outside, installing new lighting and repainting the have changed from warehousing and factory areas building can be enough sometimes to make a quick, to residential. A factory building that is no longer small profit. being used could be converted to a residential condo- Why Do The Upgrade? minium project or a shopping mall. o When an investor is looking for the proper property,

The Land Under A Business–The Most Valuable Asset Anyone who owns a home that was located in a hot The Lessor’s Benefits housing market a few years ago knows that the land When land values soar, strategies must change. An can be worth more than the actual home. Now many example could be the developer of upscale homes companies are figuring out the same about their own who wants to keep the ownership of the valuable land real estate holdings. as an investment. The use of the land can widen Many entrepreneurs spend their adult lives building the market by reducing the purchase price of the a business up so that it can be sold at their retirement house. In certain parts of the country, the value of the or passed down to their heirs. Now many of them are land equals the value of the house. Leasing the land finding that the land under the business is worth far can cut the purchase price nearly in half. With this more than the business itself. type of land lease, there is usually a provision for a Major retail firms are in this category. A lot of com- rent increase halfway through the lease term in accor- panies will be more attractive for their hard assets dance with the results of a reappraisal of the land. than their actual sales, particularly during a reces- The Lessee’s Benefits sion. The land lease results in the following benefits for a ß (continued) builder or developer: lease to a leasehold mortgage, the developer should 1. She/he can acquire a valuable parcel of land with get a reduction in rent because the unsubordination very little cash investment. will cause his or her financing to be more expensive. Subordination could be the most important item in 2. This leasehold that is acquired is an asset that can the terms of the lease. Even a short subordinated lease increase in value, and then could be used as security might be better than a longer unsubordinated lease, for a loan, or could be sold for a profit. even though the longer lease is more salable. 3. The rental payments are fully deductible by the The landowner may or may not allow the interest as lessee. If he/she had purchased the land instead of owner-lessor to be subordinated to the interest of a leasing it, only the interest portion of the payments leasehold mortgagee. When there is a subordination to would be deductible. the mortgage, the lender, in effect, gets a fee mortgage 4. With a subordinated land lease, the lessee-devel- on the land rather than a leasehold mortgage. oper gets the equivalent of a 100% loan on the land. When the lease is unsubordinated, the landowner- Land Rent and the Term of the Lease lessor has first rights over the lender in case the Usually, a developer-lessee will attempt to get the lessee-mortgagor should default. With these terms, the longest possible term in the lease because the shorter- lessee could find that he/she cannot get a loan, or can term land lease would have a smaller market for get one only at a higher rate of interest. Without the resale. A long-term land lease is generally a net lease subordination, the mortgage is, in effect, a second lien under which the lessee pays the carrying costs, in- since the lessor’s claim on the rents takes precedence cluding real estate taxes. over payments on the mortgage. When the land rental is a fixed amount, it is a per- The objections of an owner to subordination of the centage of the fair market value of the land when the lease could be as follows: lease is executed. This lease will often include a pro- 1. He/she could lose the property if the lessee defaults vision for reappraisal of the land at fixed intervals, on the leasehold mortgage. with new adjustments in the rent. In some cases, for 2. Subordination reduces his or her possibility of instance with a shopping center, the landowner might mortgaging the fee interest in the land, which would demand a share of the percentage rentals over and be a logical move for the lessor. above the fixed land rent. (Much of the income in the shopping center will come from percentage overages If the subordination were part of the terms, the land- from the sub-lessees.) owner would record the right to receive any notice of default from the leasehold mortgagee and the right to A Subordinated or Unsubordinated Lease cure the default. The expense would be reimbursed to If the owner of the land will not subordinate the the owner by adding the amount to the lessee’s rent obligation. o

Considerations In Ground Leasing Landowners may choose the ground lease as a way There are at least four things that a prospective to benefit an easy and risk-free investment vehicle land lessor should remember before entering into a and as a way to secure the long-term appreciation transaction: of the property. Sometimes a ground lease can put • In most land lease transactions, the economic return the lessor at risk. That is because the deal centers to the lessor ultimately reflects the underlying perfor- on the concept of sharing economic returns. The mance of the real estate operated by the lessee. lessor becomes a partner of the lessee because the total rent is usually determined by the lessee’s net • The lessor’s evaluation of the deal must focus on operating income or net cash flow. If the lessee does the quantity of income projected pro forma but also well, the lessor does too. However, if the lessee’s must include a clear assessment of the likelihood of business is a loser, so is the lessor. actual receipt of projected rent. Therefore, the lessor must consider the financial • Because the conditions and complexities of a land feasibility of the project. Independent analysis lease can mask the risk associated with achieving should show that the project represents the correct the projected rent levels, accurate assessments of the improvement of the site and that the projected strengths and weaknesses of the real estate is essential. payments will actually be received by the lessor. • Land lease provisions must be tested against the current fee value of the land. o Restructuring Troubled Property In any market, good or bad, there are always problem afford high risk situations. properties. Most are only troubled or problem proper- The profits can come from any one or a combination of ties because of the current ownership. Some may be circumstances. neglected only because the present owner has failed to do fairly simple things that can solve the problems. • A market turnaround caused by a boom in the local Buying property and solving problems is a profit- and/or national economy. making business. • An improved system for promoting and operating Have you seen: An empty office building. A remodeled the property. Some syndicates are being formed solely apartment house or hotel that has an excessively high to manage the troubled property with an option to buy level of vacancy. A large tract of undeveloped land when and if it hits a specified profit level. that no developer has become serious about wanting • Purchase of the property at a bargain price, often to develop. These are examples of troubled property– combined with imaginative and untraditional financing property that is a definite financial burden to continue techniques. Some lenders are asked to share the finan- to hold but which also is unattractive property to some cial risks by accepting a low initial interest rate in return prospective buyers. Unattractive, that is, until very for a big share of the profits later on. Sometimes the recently. seller of the troubled property is asked to retain a finan- The timing now seems right for investors to obtain trou- cial stake in the property and to help turn it around. The bled property. The pressure on owners and lenders with seller’s experience and involvement in the project from troubled property to get out from under the on going the start can be valuable. burden is also high. The result is that syndicates have • Including the troubled property in a larger develop- been formed to seek out and buy up troubled properties. ment plan. An office building that sits empty might High Risks Not For Everyone become part of a new industrial park with hotels, conference facilities, and residential apartments, all of Knowledgeable property developers and managers which are successful. (especially those familiar with empty or near-empty office, hotel, and apartment buildings) caution that Take another look at troubled properties in your area. buying troubled property requires taking a very high With fresh new ideas and a re-structuring of the mort- risk. The financial returns are uncertain and may be a gages, the troubles may go away, leaving a profitable long time in coming, if they come at all. This type of investment for you. o investment is not for everyone; it’s for those who can

Commercial Real Estate Representation There are a number of ways to buy, sell or exchange situation, the other members of the “consulting team” investment or commercial real estate. Having the should be the owner’s attorney and CPA. We always knowledge of what you can do in some tax situations recommend meeting with these other professionals can be the difference between an annual profit or loss during the planning and of major real estate in a property that you intend to acquire or one that transactions. you already have in inventory. As commercial brokers, we are part of your profes- The professional commercial real estate broker is in sional team. It is our job to create the real estate the position to represent clients in real estate transac- transactions that will be needed to enhance your tions by setting up sales, exchanges, , purchase estate. We should meet with our clients on a regular and sales of options, and management of real estate. basis to evaluate their present position in properties, A professional real estate practitioner must stay aware reviewing plans for future acquisitions or exchanges. of current tax laws and court decisions in order to Reviewing your plans and goals can give us the 5541 Bear Lane, Suite 240 structure transactions, but does not give legal or tax information needed to help us in moving you in new Corpus Christi, TX 78405 advice (unless he/she is also an attorney or a certified directions as soon as possible, using purchases, sales public accountant). In any complex transaction that or tax deferred exchanges. o 361-289-5168 Office might result in changes in any owner’s legal or tax 361-289-5442 Fax [email protected] www.craveyrealestate.com As commercial brokers, we are part of your professional team. It is our job to create the real estate transactions that will be needed to enhance your estate.

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