Pushing Dirt

Square Feet Blog picked up a story on a story about a class action law suit accusing Marcus and Millichap and a businessman of colluding to sell net leased property at inflated prices and and then close the businesses renting the space.

Sophisticated owner-occupants of space can use sale-leasebacks to their advantage. These sale-leasebacks are effectively financing transactions, allowing the user of space to get cash without racking up debt on its balance sheet. The transactions unlock “trapped equity” that a business can deploy to grow its business.

Sophisticated buyers of net leased property in most cases are careful to set leaseback rents at market and to avoid paying more than the “replacement cost” of the asset, i.e. the market value of the land plus the construction cost of the building in today’s dollars.

What is true is that most ‘individual, freestanding ’single tenant net leased properties” have been and remain grossly overpriced to this day. buyers  of freestanding triple net retail buildings at the peak of the market were paying $500 per square foot or (much) more and tolerating yields of 6% or lower for a 20 year lease with a drug store in a tertiary location. The buyers have typically been private buyers often with 1031 exchange dollars to invest.

Some groups like Cardinal Capital made tens of millions by buying well “wholesale” from users and then selling to these private buyers at “retail” prices.

Whether there was intent to defraud these private buyers in the case the LA Times story highlighted is unclear. In most cases these private buyers have simply just made poor decisions by overpaying for these properties. They’ve paid well over replacement cost and made bets on companies with questionable credit all in the name of deferring capital gains taxes. I don’t begrudge the brokers representing sellers in these cases; they were doing their job by fetching the best prices for their seller-clients. In the realm of commercial investment real estate, there is generally a presumption made that the parties to the transaction are sophisticated. Transaction timetables typically allow for a significant due diligence period during which buyers are expected to study to the building, the market, and the tenant.

Unless it’s a distressed or “value add” scenario, I’d never recommend a single tenant net leased asset to one of my clients in need of 1031 replacement property. I’d rather see them pay their taxes.

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