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Profiting from Real Estate Investments in the New Economy

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Guest Post: In the past, real estate appreciated consistently, and created a source of wealth because of: appreciation, depreciation, debt relief, and cash flow. Real estate was often acquired with a 20% down payment and the remaining 80% balance was financed. Properties didn’t always provide cash flow at the start of the investment because of the amount of financing that was part of the acquisition equation. However, since properties were generally going up in value, that 80/20 leverage was a good thing; the returns may have increased because of appreciation.

Times certainly have changed. The real estate market is continuing to decline and many believe the bottom of the market seems at least a couple of years away. According to Mike Scott of Dupre + Scott Apartment Advisors (a Puget Sound apartment research firm) appreciation in real estate over the next several years may be nominal. According to their report, getting a decent rate of return on investments isn’t just around the corner. They indicate it could be fifteen to twenty years away.

The question is: if we can’t rely on appreciation in the near term does that mean we should avoid real estate or real estate related investments? Not necessarily. What it does mean, is that we need new investment strategies that make the most of current market conditions.

In the old real estate world when we referred to ROI we meant: RETURN ON INVESTMENT. Today, with the collapsing real estate marketplace, people are more concerned with capital preservation rather than asset growth. In the new economy, ROI has a completely new meaning: RELIABILITY OF INCOME. With the economy changing the playing field, cash flow has become the sought after benefit, rather than appreciation or depreciation. It has become very clear that investment decisions based on the old model may need to be rethought.

Just because the economic landscape has changed doesn’t mean that there aren’t some viable investment options. One of the many opportunities afforded investors using qualified funds (IRA, Roth, etc.) is that of acquiring real estate related products rather than real estate. Real estate related investments include offerings such as private Real Estate Investment Trusts (REITs) and real estate funds.

Since it looks like appreciation may be nominal for a number of years and since one can’t take advantage of depreciation in a retirement account, I think it makes no sense to base investment decisions primarily on investment growth due to appreciation and depreciation. Rather, one should look at investment products that base investment growth on cash flow. This is where real estate related products appear to have an advantage.

A number of real estate related products currently being offered fit nicely in a retirement account. Moreover, since many investment offerings are based on new lower real estate values, they may present cash flow opportunities that may not have been previously available.

I’ll leave you with a parting thought: “Real estate investing may have fundamentally changed for the foreseeable future. Isn’t it worth investing a few minutes of your time to consider the benefits and risks of all of your investment options?” You may be intrigued by what you discover.

If you want to take a look, Contact me.


Buying Office Space , Investment Real Estate , Office Building Sales

Owners Who Negotiate Debt Reductions Could Face Tax Hits

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Mar 2, 2010 - CRE News
With property values well below where they were three years ago, borrowers are increasingly trying to negotiate reductions in their loan balances.

But doing so could trigger a substantial tax hit on any forgiveness of debt.

The tax-liability issue became fodder for headlines in recent weeks when the owner of Manhattan's Stuyvesant Town/Peter Cooper Village offered to turn the property over in a deed-in-lieu of foreclosure. Its lenders subsequently filed to foreclose.

The property's owner, a group led by Tishman Speyer Properties, won't face a tax liability on any forgiveness of debt because its cost basis in the property of roughly $5.4 billion, less any possible depreciation and capital improvements, is far greater than the $3 billion of senior debt owed. Another $1.4 billion of mezzanine debt is secured by ownership interests in the entity that owns the property. But the transfer of ownership, either through a deed-in-lieu or an actual foreclosure would trigger New York's onerous transfer tax. That tax is assessed at the rate of 3.025% of the mortgage's face value.

The transfer tax liability - it would likely be borne by the property's lenders in the event of a deed-in-lieu or a foreclosure, both of which assume the property lacks the resources to pay the tax - would total $90.75 million. But it could be reduced if the entity that owns the property, as opposed to the property itself, is transferred, according to Harvey Berenson, managing director and member of the general tax group of FTI Schonbraun McCann Group, a New York advisory firm.

In that case, the value of the underlying property determines the amount of the transfer tax. Given that StuyTown's value is said to be roughly $2 billion, the transfer tax would be about $60.5 million.

Meanwhile, given the decline in property values and the volume of debt that was written at or near the market's peak, the number of loan workouts and debt restructurings is expected to explode.

"This is happening all over the country," said Maury Golbert, tax partner at Berdon LLP, a New York tax adviser.

Most properties purchased at or near the market's peak with high-leverage financing "that's coming due now are underwater," he explained.

If the amount of debt is greater than the property's basis, or cost, the borrower would face a tax hit if any of the debt is forgiven or cancelled. And that tax would be assessed at the ordinary income level of 35%, as opposed to the 15% rate on capital gains.

So say an investor bought a property in 2003 for $50 million and because of the run-up in values was able to borrow $70 million at the market's peak in 2007. If the property is now underwater, meaning it's unable to stay current, the owner could try to negotiate a reduction in the property's debt. If successful, the property would face a tax on the amount of debt forgiven.

"If you bought in 2007 and the cost basis is big, that won't be a terrible tax result," Golbert said. But a number of long-time property investors had taken advantage of the flood of capital during the market's peak to take cash out of their properties with hefty mortgages. If those get written down, "you're looking at a more difficult tax situation," he said.

Meanwhile, owners who live in New York City would face an additional 9% hit. After federal income tax offsets are taken into account, the total tax hit could be roughly 42% on the amount of debt forgiven.

"The basic rule is if debt is forgiven, the reduction is treated as taxable income in the year it happens," Berenson explained.

But property owners facing large tax hits can defer their payments. They can, for instance, reduce the tax basis instead of recognizing income from the property whose debt has been in part forgiven. Taxing authorities are also allowing liabilities to be deferred for five years. After that, 20% of the total tax liability is due annually until it's repaid, Berenson explained.

"Lenders can foreclose, or work something out," Golbert added. In either case, depending on where the property is located, potential tax issues arise. "If you work it out, and some debt goes away," you could see a tax hit if the property's cost basis is low enough, he said.

Golbert noted that property owners facing such tax liabilities could, at least in theory, defer them by structuring tax-deferred exchanges. The problem, he said, is that such deals are difficult to structure today. They require equity and debt. If a property owner was hit by a foreclosure, chances are slim that he has sufficient equity to structure such a transaction, and "it's tough to borrow" for such exchange transactions.

Buying Office Space , Manhattan Office Space , New York Office Space , Office Building Sales , Office Space , Office Space Negotiations

Commercial Property Pricing Increasing. Has the Bottom Been Reached?

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Feb 22, 2010 - CRE News

In a sign that the period of large monthly price declines may finally be over, commercial property pricing in December increased for the second consecutive month, according to the Moody's/Real Commercial Property Price Indices, or CPPI.

The 4.1% hike to 113.58 follows a 1% gain in November that was the first monthly increase since December 2008 in the indices' all-property component. CPPI is a collaboration of Moody's Investors Service and Real Estate Analytics and tracks repeat sales of properties. December's increase also is the largest monthly gain ever recorded by the index.

Still, pricing ended last year 40.8% below its peak in October 2007, and was down 29.2% from the end of 2008. The largest monthly drops last year occurred in the first half, while prices declined at a steadily slowing pace in the second half before reversing course and heading upward in November.

"Although we are unable to conclude the bottom is here, we do feel that the period of large price declines is over," Moody's said.

It noted that higher sales volumes often indicate pricing bottoms may be near. December's 716 total sales for a combined $9 billion was up 75% by count and more than double in dollar value from November's sales activity.

December's dollar volume also was up 5% from December 2008, and marked the first year-over-year gain in volume since credit markets became dislocated in late 2007.

The December 2009 transactions included 162 repeat sales with a combined value of $2.2 billion.

Pricing in the fourth quarter of 2009 increased from the preceding quarter for every property sector except retail, which dropped 1.5% to an index of 139.61.

The office sector led the fourth-quarter pricing upticks with a 7.9% gain to 122.15. It was followed by multifamily's 7% gain to 125.89 and industrial's 5.6% rise to 127.3.

For the full year, however, pricing for each sector was down by levels that range from 19% for retail to a high of 23.2% for industrial.

Within the 10 largest metropolitan markets, office pricing in the fourth quarter increased a whopping 26.8% to 134.65, but was still down 14.6% for the entire year. New York registered the largest full-year decline in office pricing at 38.1% to 141.17.


Buying Office Space , Office Building Sales , Office Space , Office Space Negotiations

Fundamentals for Small-Cap Properties Kept Weakening in January


Feb 23, 2010 - CRE News

Fundamentals for small-capitalization properties have continued to deteriorate, according to Boxwood Means Inc., with key metrics such as rents and tenant demand weakening last month.

National rents were down across the board in January when compared to a year ago. The declines range from 3.34% to $18.94/sf for medical-office buildings, to 8.23% to $7.17/sf for industrial properties. Office properties in general saw a 4.04% decline in rents to $17.57/sf, while retail properties have seen a 6.31% drop to $17.55/sf.

When compared to a month earlier, rent declines ranged from 0.2% for medical offices to 0.74% for industrial.

Boxwood Means is a Stamford, CT, research firm that focuses on small-cap properties, which it defines as those with less than 50,000 square feet. It compiles property-level operating and sales data through a partnership with LoopNet Inc.

It also compiles Days on Market, a calculation of how long it takes to rent vacant space that it uses as a gauge for tenant demand. It said the metric is at its highest level in nine months, meaning space is languishing on the market.

Despite the bad news in the data, Boxwood Means noted that declines in rents and demand are no longer as steep as they were in previous months. But it cautioned that fundamentals would continue to weaken until the national jobs picture improved and consumer confidence rose. Today, the Conference Board reported that consumer confidence had fallen sharply this month.


Buying Office Space , Commercial Real Estate , Office Building Sales , Office Rental , Office Space , Office Space Negotiations

SBA Chief on Increasing Small Businesses' Access to Capital

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Karen MillsPhoenix Business Journal Friday, February 26, 2010 (Excerpts) - Karen Mills was sworn in as head of the U.S. Small Business Administration last April, just as the economic stimulus bill was starting to revive the SBA’s lending programs. Now she is pushing President Barack Obama’s jobs plan, which calls for increased lending to small businesses, tax breaks for hiring and business investment, and programs to help innovative businesses grow.

Mills sat down Feb. 18 with Kent Hoover, the Washington Bureau chief of American City Business Journals, to talk about increasing small businesses’ access to capital...

...We have a program called 504. It’s for owner-occupied real estate, if you expand and create jobs. Temporarily, let’s use 504 to do owner-occupied real estate refinancing -- not the bad stuff, not the speculative portfolios that have been accumulated; but owner-occupied, and you haven’t gone into default. It’s probably less risky than funding an expansion. It looks like we can do it for zero subsidy; we’ll charge a fee to take on the risk, and we’ll need a little administrative oversight. We think we can do $7 billion to $10 billion at very little or no cost to taxpayers.

We have the infrastructure to do that right now. We know the demand is going to be there. (end)

How to get a SBA Guaranteed Loan

Boston Office Space , Office Building Sales , Office Space , Office Space Negotiations , SBA Loan