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Success in the 2023 commercial real estate market. How to step up to today’s challenges and build a stronger business.

OfficeSpace.com + CORFAC in our latest blog

The commercial real estate market is constantly evolving, and brokers need to be prepared to adapt in order to succeed. In what remains of 2023, there are a number of challenges that brokers will continue to face, but there are also a number of opportunities to capitalize on. We were lucky to sit down with Jonathan Salk, the CEO of CORFAC International and talk all things CRE, and how CORFAC continues to help professionals build better businesses and lead commercial real estate into the future.

Anyone in commercial real estate knows that the current climate is saturated with challenges and that the past months have been a tough time to weather the storm, much less grow business. A few key challenges we see include interest rates, inventory, and technology’s influence on CRE sales.

 

Challenges Facing Brokers in the Current Climate of CRE

Rising interest rates and current the lending environment: 

The Federal Reserve is expected to continue raising interest rates in 2023, which will make it more expensive for businesses to borrow money to buy or lease commercial real estate. This could lead to a decline in demand for commercial real estate, which would make it more difficult for brokers to find buyers or tenants for their clients.

Low inventory: 

The commercial real estate market is currently experiencing low inventory, which means that there are fewer properties available for sale or lease. This makes it more difficult for brokers to find properties that meet the needs of their clients, and in some cases even lead to bidding wars and higher prices.

Need to grow business amidst challenging external conditions: 

The time is now… With challenging economic conditions expected to continue, simply sitting back and weathering the storm is not an option for CRE pros that want to succeed. No doubt, the broader challenges of 2023 are making it more difficult for brokers to grow their businesses. Brokers will need to be creative and strategic in order to find new clients and generate leads. 

Changing demographics: 

The demographics of the workforce are changing, with more people working from home and fewer people commuting to traditional office jobs. This is changing the demand for commercial real estate, and it is making it more difficult for brokers to predict where the market is going. 

Office is perhaps the most turbulent sector of CRE – Click to read: Is the foundation of the office sector crumbling? The future of the office – and what’s to come of the office space.

Competition from online platforms: 

Online platforms are making it easier for businesses to find commercial real estate without the help of a broker. This is cutting into the profits of brokers and making it more difficult for them to compete. It should be noted that many online resources ultimately end with connecting a broker at some point in the cycle but the impact and importance of online CRE tools and marketplaces cannot be ignored.

The need to invest in technology: 

commercial real estate as a whole has been relatively slow to adopt technology. Many seasoned veterans of the CRE world still do things “the old way” with great success. In some cases this results in resistance to implementing technology solutions which can be costly. The need to balance growth with profits and smooth operations must be considered as brokers and brokerages alike prepare to take their businesses into the years ahead.

 

Capitalizing on opportunity today to evolve your business for tomorrow.

Despite the challenges facing the CRE market in 2023, there are also a number of opportunities for brokers to capitalize on. By understanding these trends, challenges and opportunities that lie ahead, brokers can position themselves for success in the year ahead

Here are a few specific tips for capitalizing on opportunities in the CRE market in 2023. Getting connected with a brokerage network such as CORFAC is just the beginning.

Focus on niche markets: With the overall commercial real estate market becoming more competitive, it is important for brokers to focus on niche markets where they can develop expertise and build relationships.

Get involved in the community: Brokers who are active in their communities are more likely to be successful, as they will be better connected to potential clients and partners.

Stay up-to-date on industry trends: Brokers who stay up-to-date on the latest industry trends will be better equipped to capitalize on opportunities.

Use technology to your advantage: Technology can be a powerful tool for brokers, as it can help them to automate tasks, connect with clients, and market their services.

Be creative and strategic: In a challenging market, it is important for brokers to be creative and strategic in order to find new clients and generate leads.

 

Benefits of Brokerage Networks

In order to succeed in the changing CRE market, brokers need to be connected to a strong network of other brokers. Brokerage networks come in all shapes and sizes and can offer great resources for savvy brokers and brokerages looking to level up their business. 

According to Jonathan Salk, CEO of CORFAC International, “people join networks like CORFAC because they want to do business…But, at the end of the day, they want to see results.”. In this case, the results often come in the form of stronger relationships and more robust businesses better prepared to scale and take on new opportunities.

 

Brokerage networks provide brokers with a number of benefits, including:

  • Access to a wider pool of clients: Brokerage networks can give brokers access to a wider pool of clients, which can lead to more deals.
  • Shared resources: Brokerage networks can share resources, such as marketing materials and databases, which can save brokers time and money.
  • Support and training: Brokerage networks can provide brokers with support and training, which can help them to improve their skills and knowledge.

 

Capitalizing on Opportunities

While these are simple examples of how brokerage networks enable brokers to succeed, the real value lies in the finer details. Salk adds “it’s the sharing of best practices and honestly, we do that.”. He continues to give examples of some of the ways CORFAC strives to not only keep their members connected but push them to excel such as: one-on-one connections with top economists and member conferences. All aimed at adding value beyond just the network of professionals that make up CORFAC’s membership.

When asked if CORFAC’s focus is surrounded by the mentality of “better together” whether in the form of shared insights or connecting deals Salk added, “they know they’ve got people like them in 70 offices around the world. And they know if they refer a client to another office, anywhere in the world, that they’re going to get the same service”.  Not only do CORFAC members get access to one and other and enjoy the benefits of their network, but there is also value in the principals that have guided CORFAC’s success for over 30 years. 

“CORFAC is 34 years old this year. And it was founded by a small group at a conference years ago. And here we are 34 years later, as strong as ever, and basically operating on the same principles.” CORFAC’s CEO continues “They wanted to maintain their name and independence. They didn’t want to give that up. The most important thing [was] they wanted to be independent, but part of something bigger than they are. You can do business outside the network. We always preach CORFAC first, but if someone’s got a requirement and they’ve dealt with someone in another market that they’re just more comfortable with, they can do that. I mean, that principle has held.”. He adds “Corefac headquarters never gets a piece of the deal. That I don’t think you’ll find that anywhere else.”.

CORFAC’s global commercial real estate brokerage network is composed of collaborative, entrepreneurial firms that offer unmatched service to clients and provide in-depth local market expertise. You can learn more about CORFAC International by visiting www.CORFAC.com. 

The CRE market is constantly evolving, and brokers need to be prepared to adapt in order to succeed. By understanding the challenges and opportunities that lie ahead, brokers can position themselves for success in 2023 and beyond.

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What is 1031 Exchange? All Your Questions Answered

The 1031 Exchange was introduced to the Internal Revenue Code of the United States in 1921, to stimulate business and economic growth by providing relief to taxpayers through a deferral strategy. In the hands of a savvy and experienced investor, the 1031 Exchange is an excellent way to increase one’s buying power, expand one’s portfolio, and build wealth.  Section 1031 of the U.S. tax code is, however, a complex labyrinth of rules and regulations. 1031 exchanges are governed by strict IRS guidelines and can be quite complicated. This Q&A is intended to address some of the questions frequently asked by CRE professionals.

What is a 1031 exchange and how can I leverage it to my benefit?

If commercial real estate investors were required to pay tax every time they sold a property, it would limit transaction volumes, force longer hold periods, and restrict their ability to respond to – and capitalize on – changing industry and market dynamics. The 1031 exchange was designed to address these limitations by making it possible for an investor to buy and sell – or “exchange” – one commercial property for another, while deferring the capital gains tax payable on it. To qualify, the equity needs to be reinvested into a new property of equal or greater value. A 1031 exchange provides the flexibility to buy and sell more frequently, reinvest in more productive property, offload underperforming assets, and respond quickly to opportunities within the market. It is also an excellent depreciation reset tool.

What are the basic rules of the game?

To qualify for a 1031 exchange, the transaction must meet the following criteria: 

  • Both relinquished and replacement properties must be bought and sold by the same individual taxpayer or corporate entity. The only exception is a single-member LLC.Both properties must be held for investment or business purposes only. 
  • Both properties must be in the United States.The properties bought and sold must be “like-kind”. Most real estate assets qualify, but property purchased for personal use is generally excluded.
  • All proceeds from the relinquished property must be used when purchasing the replacement property. The replacement property must be of equal or greater value to the relinquished property: If the value is lower, surplus funds – sometimes called a “cash boot” – will be subject to capital gains tax.
  • A qualified intermediary needs to be commissioned to complete the exchange.Proceeds from the sale will be held in escrow by the intermediary and used to purchase the new property.
  • The property title holding cannot be altered or dissolved during the exchange process. 
  • The replacement property must be identified within 45 days and purchased within 180 days of the sale of the relinquished property. Under the “200 percent” rule, you may identify any number of replacement properties as long as their combined value does not exceed 200% of the value of the relinquished property. Under the “95 percent rule” you may identify any number of replacement properties, but you must close on all of them. 

What assets do, and don’t qualify for a 1031 exchange?

Assets bought and sold in a 1031 exchange must be considered “like-kind” – a misleading phrase that doesn’t quite mean what it implies in that properties do not need to be of the same size, composition, grade, or even asset class. You can exchange an office park for raw land for example, or a ranch for a strip mall. “Like-kind” refers more to the value of the property, than its nature and usage. The replacement property must simply be of an equal or higher value and purchased for investment or business purposes.

‍All forms of property can be exchanged, including raw land, multi- and single-family rentals, retail centers, office buildings, warehouses, industrial facilities, self-storage etc. REITs and other securities do not qualify for 1031 exchanges. Exchanges of former principal residences and vacation homes may be permitted under certain circumstances, and within strict guidelines.

What steps do I need to take, and within what timeframes, to complete the exchange process?

In a typical delayed 1031 exchange, the following steps and timelines apply:

  • ‍List your property for sale.
  • Appoint a qualified intermediary – one who is reputable, credible, and experienced – as they will play an important role in the exchange process. When the property sells, proceeds are transferred to the intermediary who holds them until the replacement property has been purchased. It is advisable to start your search for a replacement property as soon as possible; you only have 45 days to do so.It is common practice to identify 3 potential replacement properties unless you plan to invoke either the 95% or 200% rules.
  • Identify your replacement property and designate this in writing to your intermediary.
  • Conclude the purchase within 180 days of the sale of your relinquished property. (Note: the two time periods run concurrently, which means that you start counting on the closure of the sale, not the identification of a replacement property). 

The 1031 process ends when both the sale and the purchase have been concluded. In a simultaneous exchange, the sale of the original and replacement property must close on the same day.In a 1031 exchange, timing is critical.  

How long do I have to hold an exchanged property, and are there any limits on how many exchanges I can do at any given time?

For an exchange between related parties, properties must be held for at least 24 months; there is no prescribed length of time in an arm’s-length exchange providing that the property has been acquired for business or investment. There are no limitations on how many times a 1031 

Exchange can be entered into, providing that the investor has the necessary means to do so.  

What alternatives, if any, are there to the “like-kind” exchange rule?

While the traditional delayed ’like-kind’ 1031 exchange is the most widely used, there are a number of alternatives that offer tax deferment benefits:

  • A Reverse 1031 exchange allows for the replacement property to be purchased before the relinquished property is sold, providing that the investor has the necessary funds to complete the purchase. To qualify, you must transfer the new property to a qualified intermediary, identify a property for exchange within 45 days, and then complete the transaction within 180 days after the replacement property was bought.
  • A Partial 1031 exchange does not require all the proceeds from the sale of the relinquished property to be spent on the replacement one. The investor will, however, be required to pay capital gains tax on the reserved cash or cash boot.In an Improvement 1031 exchange, the replacement property can be purchased for less than the sale price of the relinquished property, providing that the remaining funds are used to make improvements to the property. 

The advantage of this exchange is that investors are not limited to existing opportunities; their exchange can fund the development of vacant land, reinvigorate derelict buildings, or build new residential communities.

Can I take cash out of a 1031 exchange?

The main purpose – and benefit – of a like-kind exchange, is to defer tax by trading “up or equal” in value, ensuring that there is no net debt relief. That said, there can be compelling reasons for wishing to generate cash from the transaction. A partial exchange is the most common means of doing so, but you will be liable for capital gains, depreciation recapture and other taxes. Two further options exist: either by refinancing the relinquished property prior to closing, or the replacement property after closing­: In the case of the former, an investor with high equity and low debt, may wish to finance or refinance the property, thereby pulling cash out, and closing with higher debt and lower cash equity. In this scenario, the investor essentially walks away with debt on the property paid off, cash in his pocket, higher debt and lower equity in his replacement property, and total tax deferral.   

To be clear: this is not a practice generally condoned by the IRS, but one could perhaps argue that if refinancing was done well in advance of the exchange, and not in anticipation of it, or if it was done for reasons other than to swap debt for equity – to mitigate cash flow problems or fund repairs or refurbishments, for example – then the investor should be able to refinance without fear of reprisal.  

The second option is to refinance the replacement property after closing, and this is perfectly permissible given that the investor’s position is no different to that of anyone else owning and paying off a property. 

Is the 1031 Exchange living on borrowed time?

Yes. And no. We can take some comfort from the fact that a total elimination of the 1031 exchange doesn’t appear to be on the cards. On the other hand, the proposed amendments and imposition of a $ 500,000 tax deferral cap, will definitely negatively impact commercial real estate trading, going forward.According to a study by Ernst & Young, “President Biden’s proposal will not only severely limit the property values that investors can use in an exchange, but also adversely impact the overall economy. While this proposal is intended to generate $1.95 billion in revenue for the government through taxing the sale of real estate, many people don’t realize that taxes paid and related to businesses using like-kind exchanges were already projected to produce $7.8 billion for the IRS last year”. 

There are many compelling reasons to leave the 1031 exchange just as it is – and many supporters lobbying congress – so we should remain hopeful that common sense will prevail. That said, you’d be well advised to prepare for some tightening of federal tax regulations in the coming months along with further restrictions on deferral thresholds. Stay vigilant, monitor any potential reforms closely, and start considering some alternatives – like qualified opportunity zone funds, tenants-in common cash-outs, direct purchases of triple-net (NNN) properties, and Delaware statutory trusts – all of which offer tax deferral opportunities.

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Is the foundation of the office sector crumbling? The future of the office – and what’s to come of the office space.

Office present and office past

The economic uncertainty of the past two years has no doubt taken its toll on commercial real estate – particularly in the office sector. With many companies adopting remote work policies, office vacancy rates have risen in many cities, and landlords have faced a difficult market. In some cases, companies have renegotiated their lease terms or decided to sublease their excess office space. This has resulted in downward pressure on rental rates and overall property valuations.

While interest rates remain on the rise and many assets across all classes are headed towards distress, some markets show signs of improvement, while others are feeling the pressure. 

However, it’s not all bad news for office spaces as an asset class. While some companies have adopted remote work policies, many others have remained committed to the traditional office setting. Some businesses have even increased their demand for office spaces as a way to comply with social distancing requirements and to ensure their employees have a safe and productive workspace.

While uncertainty surrounds the future of the office as a workspace, the more important question is this: what is to come of the office building? 

 

What is to come of office spaces and buildings?

While office as an asset class has certainly been in the spotlight over the last year or two, it is time to start considering the new realities faced by these assets. We’ll cover this from two perspectives: the office as a workspace, the office building as a commercial asset.

 

The office – a common workplace…but is it timeless?

Most of us have, or are currently working from an office. A staple and widely accepted workplace setting leading up to the COVID-19 pandemic. Since 2020, we’ve seen a shift to remote and hybrid work leading to a dramatic decrease in office utilization and in some cases necessity. The question remains: will this shift to remote and/or hybrid be permanent?

The shift from a largely full-time in-office setting to hybrid and remote was fueled by concerns around social distancing amid the pandemic and happened quickly. As we’ve seen, the return to the office has been much slower, and in some cases hybrid and fully remote work may continue. However, while these settings may be successful for specific roles and organizations, the office itself has been cemented as a standard workplace over time. While the transition back to a predominantly office environment may take time, it is a very likely trend that has already begun to emerge. What remains to be seen is at what capacity will office work make its comeback – will the office be the norm once again, or is hybrid here to stay?

 

The office building

Surrounded by uncertainty in demand, the next question is what’s to come for the office building itself. Offices come in many different shapes, sizes, and values, and as anyone in commercial real estate knows, they’re present in every market. Along with massive variance in value, these assets carry varying levels and types of (often complex) debt and most importantly varying capability to produce positive returns.

With cheap debt no longer on the table and high amounts of vacancy, many assets are reaching debt maturity and lacking the profits necessary to effectively refinance at current rates. So, what are the options for owners facing tough times amidst challenging market conditions?

 

Weather the storm

While difficult – one option for underperforming assets is to wait out the current market conditions and hope for a change in office sentiment and interest rates. Assets that are able to stay afloat amid vacancies and tough financing are more likely to become profitable again in the future. In some cases, owners may be able to restructure their financing. This may require demonstrating a viable plan to improve the property’s performance and may involve additional fees or covenants. Further, owners may seek to bring in new equity partners to inject additional capital into the property and pay off the existing debt. This may require negotiating with the existing lender to subordinate the debt or convert it into equity.

 

Convert?

Another possibility is adapting the office building. Converting a standard office to apartments or retail, or a mix while possible is tremendously expensive and not always a viable option – dependent on the particular building based on a myriad of factors including: location, zoning, size, layout, etc.

Using some general assumptions – the average office building in the U.S. is around 20,000 sq./ft.. And the costs to renovate an office into an apartment and/or retail can be between $100-$300 sq./ft. It could cost upwards of $6,000,000 to update the average office building before it’s ever able to generate revenue aside from traditionally leased office space. Compare this to a rough estimate of that 20,000 sq./ft. Office asset’s approximate value of $5-6 million dollars and the cost of converting is extremely steep and carries a high level of risk if the newly renovated asset cannot perform and meet its debt obligations. 

It’s important to note that while the cost of converting an office building into apartments (or other types of commercial space) can be significant, the potential returns on investment can also be substantial, particularly in high-demand urban areas where there is a shortage of affordable housing. With careful planning and execution, converting an office building into apartments can be a viable and profitable investment strategy for real estate developers and investors.

 

The future of office

Despite the widespread adoption of remote work, it’s unlikely that the traditional office space will disappear altogether. In-person collaboration and face-to-face meetings are still essential for many businesses, and there will always be a need for physical office spaces. However, the office spaces of the future may look quite different from those of the past.

Owners and investors of office assets must be prepared to adapt or weather the storm of current economic challenges. Like all markets, commercial real estate has its ups and downs. Investors who are able to hold their assets amid these tough times have the potential to see profits return in the future as the economy recovers, and as more workers return to the office. Additionally, there will be opportunity for savvy investors large and small to capitalize on distressed office assets as some will ultimately fail. 

The only certainty in the CRE markets of 2023 is that uncertainty is likely to prevail. Investors must remain vigilant and ready to entertain and embrace new ideas and the new reality of the office sector.

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Looking Forward, The Price of Uncertainty…

On this day every year we can’t help but stop and think about what happened, we get lost in thought – where we were, and how we felt. We remember the tragedy and remain curious about the details of the final memorial space. Eleven years later it seems there’s may be some closure on the status of the 16 acre site or is there?

Announced on the eve of the anniversary, funding support was finally sorted for the memorial museum although no completion date has been set, progress none the less. And, there seems to be cautious optimism on the leasing front as at least 1/2 the skyscrapers are expected to be filled over the next 5 to 8 years. Douglas Durst, chairman of the Durst Organization, which is co-developing One World Trade Center and handling its leasing for the Port Authority, has outlined a very positive attitude “We’re very optimistic that we’ll have the building fully rented by the date of 2017, 2018,”. A considerable percentage of the 3 million square feet of office space has already been reserved by publishing giant Conde Nast, who is rumored to be taking 25 floors. Said to be “like a stamp of approval” by Dan Fasulo, managing director for Real Capital Analytics, a commercial real estate research firm, Conde Nast’s presence will definitely be an asset in attracting other businesses.Image

Despite huge costs associated with effectively running the former WTC site, it’s museum and the memorial, it seems those involved feel the rise in commercial real estate, visitors to the site (4.5 million since last year’s 10th anniversary), government support and donations will aid in offsetting the financial responsibilities. After the 1993 truck bombing it was next to impossible to find businesses to secure space at the site. However, the neighborhood has changed, there’s much more happening in lower Manhattan than there was 20 years ago so it’s difficult to predict whether this optimism is on the mark.

Do you think this is a fair estimation of time considering some of the towers have not yet begun construction? Would you consider leasing in the former WTC space? Do you think the 60 million a year operating budget can be responsibly maintained without further borrowing and debt being accumulated?