Impacts of the Digital Revolution

As we continue through the digital revolution, we are constantly bombarded with new software on a regular basis. Often these new upgrades promise improvements in productivity, efficiency and value.
However, these advances do not come without potential consequences such as the impact on employment. This risk is often referred to as technological unemployment. Artificial Intelligence (AI) and Augmented Reality (AR) advances are no exception and do not go without unemployment risks for many industries in the service sector including the CRE community.
If you were born before the early 80’s, you probably remember when Marty McFly first took the DeLorean to California where he landed in the future year of 2015. He flew around on a hover board (while escaping Biff Tannen), wore an automatically drying jacket and thought we was going to be eaten by a great white shark hologram.
Some of these futuristic advances may be slightly behind, but the Augmented Reality (hologram scenario) is quickly making its way into many major markets around the world. In the day and age where companies obtain value through monitoring our purchases and habits, retailers are already using new technology for facial recognition so they can identify shoppers for a variety of reasons.
At a recent CRE tech conference, the prospects of AR advances left many brokers wondering how their future revenue stream will be affected. We were shown many platforms that are already in place at many large markets worldwide and also some that will be hitting mainstream after a few more small advancements. We witnessed AR glasses which allowed shoppers to view “pop out” advertisements while they walked down the street (some tailored directly to them due to facial recognition). We also saw high-rise buildings with huge AR banners on them. This lends the question as to who has the rights to the revenue stream from that advertisement and will the building owner even be aware. How will this advancement change the value of these high-rise buildings? Though there are certainly negative views on these advances, some are embracing it due to the sheer efficiency and experience they receive.
Specific to real estate and the advisors in the room, we witnessed AR glasses which allowed for an individual to look at a building and see a variety of factors such as vacancies, occupants, rental rates, building efficiencies, building amenities and much more. What caused the bubble in the room to deflate was when a video popped up showing a hologram real estate agent who was taking a client on a tour. The prospective lessee was able to put the glasses on and receive a guided tour of the city and specific buildings, where this individual could see which spaces were available to them and were even able to walk into the space and project possible finishes and buildouts real time. All without a real-life real estate agent.
As with all service-related jobs, we have to bring value to the end consumer. Even more so with these technological advances, real estate experts need to think beyond the box to strategize how they will continue to bring value to clients. One thing that it doesn’t appear AI or AR will be able to compete with (as of now) is the emotional intelligence of humans.

King Weed

Eras in this country have been sometimes defined by commodities. There was King Cotton, then King Corn. Now we have King Weed. The demand for legalized marijuana in Michigan is enormous. Three-hour long waits at retail establishments to buy adult use product is reality. Societal change has arrived.

Approaching the new year, what is of importance to commercial Realtors and their clients? The easiest answer is the size of the market, which has gone from approximately 350,000 registered Michigan Medical Marijuana caregivers and patients to 9.9 million people for Adult Use (sometimes called “Recreational”). It’s the same plant as sold for medical marijuana. It doesn’t know the difference; it just has an expanded market.

With the expanded market now, there’s a tremendous demand for viable licensable properties. People interested in the marijuana industry are everywhere searching for locations. You need to learn which municipalities will allow which Medical Marijuana and Adult Use activities, how licenses are awarded, and how to creatively structure offers and leases, often pending licensing approvals.

Some other highlights and thoughts you need to understand for 2020:

• Municipalities still control their own fate. Are they in or are they out? They can be in, to a limited extent, by limiting the types of facilities and numbers of each (currently, there are only a handful of municipalities allowing adult use).

• We foresee a significant increase in the number of municipalities which will allow Adult Use facilities over the next year. Find them! Many of those municipalities indicated they wanted to wait to see what the Adult Use rules are. Emergency Rules have now been adopted. Municipalities are often slow to react and the leaders reluctant to leap into this arena until they see their neighbors taking advantage of the opportunities presented by these facilities. Unless things radically change, these facilities are not expecting tax breaks or money from the MEDC. They pay their full share for a fully taxable piece of property.

• Besides the usual Grower, Processor, and Retail Sale licenses, there are others under the Adult Use canopy which Realtors need to learn about as their clients may want to take advantage of them. These include:

o “Consumption Establishment.” In parlance that’s a “smoking lounge.” Put those adjacent to restaurants, event facilities, or at a golf course. Make it like a video arcade?
o Marijuana Event Organizers. If your client has a large open space such as a field, a mall, or a parking lot, what about having a temporary marijuana event at that location? There are the obvious places like music festivals. People can come, buy merchandise, and smoke at the event. It’s doubtful we will see it on Calder Plaza this summer, but one never knows. What about at a football or baseball stadium?
o Delivery License. This license is not yet available. It’s in the proposed Rules and we expect it will pass. This will allow a delivery service to take product from the retail shop to an individual’s residence. It is not a secured transport and essentially replaces the requirement that home deliveries be by an employee of the retail entity.

• We also predict, which will be the impetus for further tremendous increased expansion in the industry, that the two-year lockout of non-MMFLA licensees is reduced to one year. Right now, the MMFLA licensees who are getting Adult Use licenses have that two-year protection from November 1, 2019. The change, if it occurs, would mean that any applicant could get the major Adult Use licenses beginning November 1, 2020. This is my prediction. I have no substantiation for it other than just my experience in this industry and reading the tea leaves.

What should Realtors do if they want to work with businesses in this new field?

1. Help their clients understand the municipal ordinances which grant marijuana business opportunities, including restrictions on license numbers, locations, and buffer zones.
2. In evaluating possible locations for their clients, understand the costs associated with such a development and the length of time required for construction/build-out and the license process.
3. Recognize that property values are constantly changing in this new world of marijuana business as more municipalities jump into the business arena. Costs for electricity, water and transportation through a Secured Transporter play significant roles in determining value.
4. Since this is a cash business, understand the requirements of Currency Transaction Reporting (Form 8300) for those receiving cash payments. This includes landlords. Recording requirements relate to “a series of transactions,” not just to each individual payment. If you are a landlord or property manager, it will be best if you understand its requirements.
5. Learn the future of the industry so that you can help your clients best evaluate options and opportunities for initial operations, optional licenses, and expansion opportunities.

The “Wacky Weed” dominates the real estate market as a new year and a new decade dawn. Realtors take heart; the expansion of this new growth business has just begun. Opportunities abound for those willing to learn and work.

Cannabis keeps on growing.

Letters Of Intent Are Dangerous

Letters of intent, although common in real estate transactions, are dangerous. In Michigan, courts have ruled that a letter of intent (LOI) can be binding even though it says things like “non-binding”, “only preliminary to a definitive agreement”, and the like.

Courts reach such surprising results most often where 1) the LOI contains a detailed list of many of the deal terms, and 2) both parties have signed the LOI.

Why is the LOI sender asking the recipient to sign if the LOI is supposed to be nonbinding? If you receive an LOI asking for your signature, consider responding this way:

“Thanks for your letter dated _________. We did receive it, but we will not be signing it because we have no agreement with you at this time. We look forward to continuing negotiations with you.”

If you can’t resist sending some status report to the other side, put only a few of the significant deal terms onto a “term sheet”. And do not ask the other side to sign it.

Sure, sometimes you want an agreement with the other side, typically on such things as confidentiality and exclusivity of negotiations for a fixed time period. So put those two subjects into a separate letter that the receiving party signs. But say nothing about the deal terms.

In summary, the traditional approach to letters of intent creates a significant potential for surprise. Work with your legal counsel to abandon this dangerous, traditional approach in favor of one that is easier, more direct, and safer.

Retail Market Overview-November 2019

The retail market within West Michigan has been incredibly strong as begin the 2019 holiday season. Both national and local retailers continue to look for opportunities within the market but due to all 50-year low unemployment rates at 3.1%, high construction costs and limited inventory their searches are becoming more difficult. Even with several Big Box store closing throughout the nation, the retail sectors continue to flourish based highly off Restaurant and Fitness retailed concepts. Brick-and-Mortar stores still account for a large portion of overall spending. A recent report stated that 83% of consumers plan on shopping within a store during this upcoming holiday season.

A large amount of transactions and high level of interest continues to be around the 28th Street & East Beltline location. Labeled as the, “Main & Main” within West Michigan this corridor has seen REI, Von Maur, Black Rock Grill, MOD Pizza, Panda Express and others open in 2019. The rental rates within this area are some of the highest within the market. Another area that has seen a strong amount of activity has been East Beltline & Knapp. With the recent addition of TJ Maxx, Old Navy, Five Below, Orange Theory, Amazing Lash Studio, Woodhouse Day Spa and Clean Juice this corridor has drawn the attention of a handful of retailers and restaurants. Alpine Ave continues to push farther north with a new strip center built which includes an endcap drive thru Jimmy Johns. Even with TJ Maxx relocating from Alpine to the East Beltline this area continues to draw high level of interest. Rivertown saw the addition of two fitness users this past year Twisted Hot Yoga and Title Boxing. Both concepts are new to the Grandville market and have opened very strong!

Downtown Grand Rapids has seen immense growth and continues to see shape our West Michigan landscape. The addition of Studio Park has brought even more patrons into downtown. 20 Monroe Live, Van Andel Arena and DeVos Place continue to draw more and more crowds and attractions to each of their venues. The West Side of Grand Rapids has begun to become the “hot spot” in town with Bridge Street Market, WMCat, Consumer Energy starting construction in Spring of 2020. The restaurants of Butchers Union, Jolly Pumpkin, Sovengard, and New Holland Brewery have been strong additions to this stretch. The Wealthy and Cherry Street corridors continue to draw strong levels of interest as some of the highest rental rates within the downtown district are located here.

2020 should continue to be a strong year for West Michigan retailers. Much of the action will continue to be around 28th Street, East Beltline, Rivertown and Alpine Ave. These retailers will be faced with some of the same issues which plagued 2019, lack of employees, high construction costs and lack of inventory but West Michigan continues to be a strong economy for many of them. As more regional and national companies look at the market it will continue to bring bodies into the market who need to eat, shop and help many of the retailers!

Real Property Valuation Issues - Fee Simple versus Leased Fee

Valuation theory holds that interests or rights in real estate are to be valued rather than physical land and buildings themselves. Standards require that interests or rights be identified and reported. In ordering and completing appraisal reports then, the issue of which property rights should be valued often comes up. The primary property rights in appraisals are Fee Simple Estate or Leased Fee Estate. Fee simple includes the “full bundle” of rights while leases convey partial property rights to tenants for their use and occupancy. Following are definitions currently in use by the valuation profession (Dictionary of Real Estate Appraisal, 6th edition):
Fee Simple Estate – Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.
Leased Fee Estate – The ownership interest that the landlord or lessor maintains in a property under a lease with the rights of use and occupancy being conveyed or granted to a tenant or lessee. The ownership interest in a leased property.
If not spelled out specifically, there may be some differences in interpretation among appraisers as to whether a leased fee or fee simple value should be presented. Many banks may take a generally prevailing view that if there is a lease, you must present the leased fee interest. However, as an appraiser it often generates questions such as, “shouldn’t we be determining how a typical buyer would view the lease and its impact on value? Should you really present the leased fee interest if there’s only a short term lease or leases remaining?

A desire for more consistency on these matters prompted the Appraisal Institute to hold discussions on and draft a Property Rights Symposium Discussion Paper (12/21/17). When a property is leased and the value of a lease interest is sought, the valuation process will reflect the lease and account for any loss or benefit due to the rent being above or below market or loss due to the time and cost to lease vacant space. But when the assignment is to value the fee simple estate in property that is typically leased and sold as leased, questions arise as to whether it should be valued as though occupied or as though vacant. This question is critical in eminent domain and property taxation where law or regulation generally requires the valuation of the fee simple estate, even if a lease exists. It is also an important question in mortgage lending when lease income is needed to repay the loan but there is risk of unexpected vacancy. The paper brings up the issue: does fee simple mean vacant and available for lease or occupancy? If so, should deductions be made for lease up time and cost? Does fee simple imply a “go dark” scenario? Also, how does the interest valued relate to your selection and adjustment of comps, and selection of an appropriate capitalization rate? The symposium concludes that the definition of fee simple may need changes. They suggest: “Fee simple estate. The highest estate allowed by law. An inheritable ownership interest of indefinite duration.” In addition, it was suggested that the valuation profession discontinue use of the terms leased fee and leased fee estate. Potential implications of these proposals are that valuers would need to determine, and valuation reports clearly state, the estate (fee simple, leasehold, or life estate) as well as the actual or assumed interests associated with the real estate that are reflected in the valuation. Depending on the question to be answered by the valuation for a property that is leased, or would likely be leased, the valuation could be subject to the existing lease, subject to leases at market rates and terms, or as though vacant and available to be leased at market rates and terms. The valuer generally must consult with the client to clarify which interests to value.

Application in sale and income approaches: the concept of “market value” is linked to specified property rights. It is the “transfer” (a hypothetical sale, the foundation of an opinion of value by an appraiser) where property rights intersect with the concept of market value, because every sale will have a transfer of some rights. So to appraise a subject property we hypothetically create the situation of a “transfer” or sale, and with that hypothetical sale we have to specify which set of property rights are transferred so that the type of value we are opining is clear. Accordingly, every sale comparable that has transferred did so with a specified set of property rights, and thus has to either match the property rights stated in the appraisal of the subject property or be adjusted appropriately. When the fee simple interest is valued, the presumption is that the property is available to be leased at market rates. A lease at market rent would not increase the market value of real property rights to the fee simple estate. Any potential value increment in excess of a fee simple estate is attributable to the particular lease contract”. (The Appraisal of Real Estate, 14th Ed., Chapter 21: The Income Capitalization Approach, p. 441). In the development and analysis for the Income Approach to Value, an appraiser may find that the lease terms are in line with current market conditions, and therefore, the value of the leased fee estate may be equivalent to the fee simple estate, but the property rights appraised and market value label should be leased fee estate for technical accuracy and consistency with appraisal industry standards and practice. Conversely, if the market rent is found to be greater or less than the contract rent, a leasehold estate exists in which the tenant holds positive or negative leasehold position.
I often order appraisal reports requesting that both a “leased fee” and a hypothetical “fee simple” value estimate are to be provided. This may help a bank to better analyze collateral from a lease contract/risk perspective, as well as a hypothetical “fee simple” with an assumption made that the property is available for lease at market rates and market risk. Usually, a “stabilized value” is sought in this fee simple hypothetical as though the property has achieved stabilized leaseup at market rents. An alternative value could also be sought in some cases for a “go dark” scenario with assumption that the property is vacated and available for sale.
Disclaimer: this blog is the opinion of the writer only and does not necessarily reflect the views of the writer’s employer.